What is Earnest Money?

During the homebuying process, you may come across terms that are unfamiliar. Like restaurants and the theater, the real estate industry has its own lingo, which can be intimidating, especially to first-time home buyers. One of the phrases you should definitely know is “earnest money.”

What is earnest money, and what role does it play in your homebuying journey? Our knowledgeable local experts are here to help you develop a strategic plan that will make earnest money work for you.

An Earnest Payment

Earnest money is a good-faith deposit that you make on a property along with your offer or contract to demonstrate your commitment to completing the transaction. The money is deposited in an escrow account until closing, and then it will be applied toward the purchase price. It is usually viewed as a part of your down payment, rather than being “in addition to” your down payment funds. 

Consider it the ring that traditionally accompanies a marriage proposal. While it’s not required, it is typical, expected in fact. In a highly competitive housing market where inventory is low, a more substantial earnest money deposit may be the difference between securing a deal or losing out to another prospective buyer. 

The contract that establishes the earnest money commitment ensures that the home is taken off the market (generally moved into “contingent” or “pending” status in the Multiple Listing Service) during this period, committing to other interested parties that there are substantial barriers to being snapped up by a more enthusiastic buyer. 

It also gives the involved parties a specific timeframe to complete certain crucial steps before the sale can be finalized, such as title clearance, a professional home inspection, and the property appraisal. 

How Much Should You Offer?

The ideal amount of your earnest money offer depends on several factors. Here are some of the main influences on how much you can expect to put down:

  • If you’re in a seller’s market, a high deposit gets attention and helps your offer stand out. 
  • What’s the custom in your area? Consult with your real estate agent about the going amount for your location. 
  • The national average is about 3% of the total purchase price. In Wisconsin, a typical earnest money deposit might be 1% of the home’s purchase price, while in Illinois, it is common to see the deposit made in two separate payments, totaling somewhere between 2-10% of the home’s purchase price.
  • New construction home sales usually demand a higher earnest money deposit, which can be as much as 10%.
  • Some sellers request a fixed amount, such as $5K, $10K, or more. 

Keep in mind that you should never give funds directly to the seller. If issues are found with the home that nullifies the contract, you could have problems recouping money that’s not held in an escrow account by a trusted third party.  That trusted third party is most likely the seller’s real estate attorney or title company, though sometimes it could be the seller’s real estate brokerage or the buyer’s attorney. 

What Happens Next?

Once you know how much to offer in earnest money and the seller accepts it, you’ll sign a real estate purchase contract. This is a written agreement between both parties and helps to prevent fraud. Your purchase contract will cover your rights and obligations, have an itemized list of your closing costs, and will most likely include several contingencies.

While everyone hopes the home buying process goes smoothly, it sometimes doesn’t, for a variety of reasons. Having contingencies in your contract protects you from losing your earnest money deposit or making a real estate investment that you’ll regret. 

The wording on your contract may vary, but here are the most common types of contingencies:

  • Unsatisfactory home inspection
  • Unclear title (or cloud on title?)
  • Poor condition of sewer lines
  • Unusable private well
  • Mold
  • Structural damage

If your contract is canceled by one of these deal-breakers, you are entitled to the return of your earnest money.. However, if you waive contingencies or don’t follow the timeline to complete the purchase as listed in the contract, your earnest money is forfeited.

Protect Yourself

Buying a new home for your family is an exciting time, but it’s important to work with an experienced team that gives you a clear advantage. In this volatile market, there are plenty of real estate scams and unscrupulous sellers. 

The number one way to protect your interests is to get everything in writing. If something dreadful happens and you end up in court, if it’s not in writing, it doesn’t exist. Make sure your contract specifies exactly how you get your money back if everything goes south.

Keep all funds in a secure escrow account. Your title company is a vital player in this process and will be able to answer any questions you might have regarding your earnest money payment.

In some states, like Illinois, it is commonplace for real estate contracts to be reviewed by a licensed attorney who specializes in these details. Even if it’s not the law in your area, it’s always an excellent idea to seek counsel when it comes to contracts and large financial transactions.

Almost all purchase agreements have strict timelines that must be met or the contract is nullified. Read all your paperwork carefully, submit your documents on time, and meet every deadline to avoid breaching the contract and losing your deposit.

The Bottom Line

Everyone deserves to achieve their financial goals and buying a home can help you reach them faster. At Landtrust Title Services, we work closely with our clients to give them a clear advantage in this market with the benefit of our in-depth knowledge and experience. 

More than just a title company, we’re proud to offer our community a variety of services and be a true partner throughout the home buying odyssey. Ready to take the next step? Reach out today!

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