What Is Earnest Money In Real Estate?
Earnest money is a type of security deposit made to a home seller that shows the home buyer is serious about purchasing the home. This is a more informal part of a home purchase and purchase contract. Often confused with a good faith deposit, an earnest money deposit allots you a certain amount of time to secure your mortgage financing and complete the other steps in the home buying process, like appraisals and home inspections. Typically, an earnest money deposit is only refundable under certain circumstances.
Let’s take a closer look at earnest money and how it differs from a good faith deposit.
How Much Do I Need For An Earnest Money Deposit?
The amount you need for an earnest money deposit is calculated by a fixed amount or percentage, depending on what market you’re in.
Fixed amount: In certain markets, there’s a fixed amount that’s a standard earnest money deposit, say $5,000, regardless of the purchase price. This is the amount that you would submit after the purchase agreement is accepted.
Percentage: In other markets, common practice will be to have the earnest money tied to a certain percentage of the purchase price. For example, if the standard deposit in your area is 3%, the deposit would be $6,000 on a home with a $200,000 purchase price.
If you’re working with a real estate agent or other market professional, they can tell you what you can expect to pay as an earnest money deposit in your area. Remember that, once deposited into an escrow account, your earnest money will earn interest. Meet with your accountant to retrieve the interest earned if it’s greater than $600.
What If I’m Buying In A Competitive Market?
An earnest money deposit can differentiate you from other buyers making offers in a highly competitive market. Remember, the purpose of earnest money is to reassure the seller of your intention to buy. If you have the savings, a larger earnest money deposit can signal a more secure transaction and make your offer more attractive.
Assuming you close your loan, any sum of your earnest money deposit goes toward your down payment anyway, not the seller’s pocket. However, having a higher deposit may cause the seller to think that you’re more serious. Having more money on hand can also be a sign of financial stability, so sellers might reasonably think that the transaction is less likely to fall through at the last minute if you don’t qualify for a mortgage.
Finally, at least part of the reason for an earnest money deposit is that it’s intended to compensate the seller for taking their property off the market so you can have time to finalize the details of the transaction. Although there are ways in which you can protect your deposit in order to get it back under certain circumstances, the compensation of the deposit offers assurance to the seller that you mean business. Unless you get it back based on a clause negotiated in the purchase agreement, they can keep the earnest money if the sale doesn’t close. This could help motivate them to take the property off the market.
How Do I Ensure My Earnest Money Is Refundable?
If you don’t end up closing on the mortgage, you can potentially end up losing your deposit. However, there are also certain ways to increase your odds of getting it back.
Common Earnest Money Contingencies
The only way to guarantee you’ll get your earnest money deposit back from escrow under a given scenario is to have a contingency in your purchase agreement. There are several types of contingencies you can use to try and protect your deposit:
- Home inspection contingency: You can write into your purchase agreement that you get your deposit back if something specific comes up in the home inspection. This clause is generally limited to major issues like a home needing a new roof or an HVAC system.
- Appraisal contingency: An appraisal contingency gets you your deposit back if the home doesn’t appraise for the purchase price, which is important because the lender can’t give you more than the house is worth. It may not get this far, as sellers may be willing to go back to the negotiation table with you at this point to make the transaction workable, though that’s not always the case.
- Financing contingency: If you had this contingency included in your agreement, you can get your deposit back if your mortgage financing falls through.
- Existing home sale contingency: If you’re trying to sell your current home while buying your new one, you may negotiate to have the purchase contingent on the sale of your prior home so that you don’t have to make two mortgage payments.
Purchase agreements are negotiations. Not every contingency is going to be agreed to by the seller in many cases. Sellers who are particularly motivated to sell their home may balk at someone asking for too many contingencies in the purchase agreement, but it’s understandable to want some protection. It’s a balance. The bottom line is that you should be aware of the terms of your purchase agreement so that you know when you can and can’t get your money back.
What Is A Good Faith Deposit?
The term “good faith deposit” is sometimes used interchangeably with “earnest money deposit.” While earnest money is indirectly given to the sellers, a good faith deposit is paid to the lender with the same intent – to illustrate a commitment to move forward in the mortgage process.
Just like your earnest money deposit, if you close on your home, the good faith deposit goes toward covering your closing costs. Lenders use your good faith deposit to pay for things like appraisals, credit checks and other costs associated with processing your loan, including underwriting and reviewing your documentation, along with contacting insurance and title companies.
How Much Do You Need For A Good Faith Deposit?
If the term “good faith deposit” is being used synonymously with “earnest money deposit,” how much you need to pay is covered in the earnest money sections above. However, when referring to a good faith deposit to a lender, the amount of the fee is going to vary based on their policies.
At Rocket Mortgage®, a good faith deposit ranges from $400 – $750. The reasons for the range are that certain services like appraisals and surveys (if a survey is necessary) vary in cost, depending on the market. You’ll get a deposit agreement that breaks down the actual cost of your deposit and explains in detail what the money is used for.
Protecting Your Earnest Money Deposit
If you’re giving earnest money, there are some actions beyond contingencies that you can take to protect it and ensure that it either gets used for its intended purpose on your closing costs or can be refunded when the appropriate contingency is triggered.
Never give earnest money directly to the seller. You always want to give it to a third party. The best option is to have the title company put it in an escrow account. Get a receipt.
Unlike an earnest money deposit, a lender’s good faith deposit isn’t generally fully refundable. However, Rocket Mortgage will refund any portion of the deposit that hasn’t already been used to work on your loan in the event that the transaction doesn’t close.
The home buying process involves a large financial transaction and can certainly be a complex journey with many checkpoints along the way, but having a better understanding of what to expect should help give you the confidence you need to move forward.