You’ve found the perfect new home, and made your offer. It’s been accepted, maybe after a bit of back-and-forth with the seller’s agent. Your agent calls and lets you know that the contract is ready to be signed, and it’s time to make your “initial earnest money deposit.” Understanding more about earnest money, how much you’re likely to need, and its role in the purchase, escrow, and closing process will help you be a more informed, prepared buyer, and could make all the difference between sealing the deal on your dream home or missing out on the deal of a lifetime.
Earnest Money Defined
Earnest money, also known as a good-faith deposit, is a cash deposit intended to confirm your intent to follow through with a real estate purchase. In any real estate transaction, accepting an offer means the seller takes the property off the market to complete the deal – a failed deal means the seller has to go through the time and trouble of allowing inspections and even starting on repairs, all for the deal to fall through and force the seller to relist the home. The seller is taking a risk — if the market changes during the time the sale is pending, the seller stands to lose money. Earnest money ensures that both parties stand to lose if the sale falls apart for reasons other than the contingencies outlined in the contract itself.
Earnest money is typically held in an escrow account while the sale is pending. It is returned to the buyer if the transaction fails for any contingency specified in the sale contract.
Typical reasons for the return of earnest money include the home “failing” inspection, or the buyer and seller not being able to agree to final contract terms. If the buyer backs out of the deal for a reason not specified in the sale contract, or is unable to close the deal within the period specified in the sale contract, the earnest money is forfeited to the seller.
How Much Earnest Money Should I Expect To Pay?
The typical earnest money amount is between one and three percent of the purchase price of the home. In particularly hot real estate markets, a higher earnest money offer might help to seal the deal on a home purchase — depending on the number of offers, an earnest money deposit of up to five, or even ten percent of the purchase price may be necessary to secure an acceptance. In some markets, a flat earnest money amount may be more common. Your real estate agent can advise you of the custom and practice in your area.
Your real estate agent can advise you as to the earnest money deposit that might help your offer get noticed. It is important for buyers to remember that the earnest money deposit you offer will be applied to your down payment amount at closing or returned to you if the deal falls through based upon the failure of a contingency, so it is generally fairly low-risk to make a somewhat more substantial earnest money deposit if the buyer is confident that the sale will go through.
How Do I Pay Earnest Money?
The buyer pays the earnest money deposit by providing a certified check, personal check, or a wire transfer into an escrow account that is held by a neutral third party, usually the listing agent’s real estate office or the title company facilitating the title search and closing. The funds are held in the escrow account until closing, when they are applied to the buyer’s down payment and closing costs. These escrow accounts, which remain open from the date of deposit until closing – usually between 21 and 60 days – can earn interest, like any account. If the earnest funds in the escrow account earn interest of more than $600, the buyer must fill out tax form W-9 with the IRS to receive the interest.
In many cases, earnest money will be deposited in two separate payments. In many markets, it is customary for the buyer to make an “initial earnest money deposit” after the terms of the deal have been agreed to by all parties, and then a second deposit (“balance of earnest”) after some other contract milestone – the end of the attorney review period in Illinois, for example.
Protect Your Earnest Money Investment!
Buyers should keep an eye out for two main risks to their earnest money deposit: failure of the sale, and fraud.
Failure To Close
The first major risk to a buyer’s earnest money is the failure of the home sale agreement for a reason not specified in the contract. Virtually all home sale contracts contain a number of contingencies, or conditions that must be fulfilled before the contract is considered binding. Among the most common of these are the home inspection contingency, the title contingency, the attorney review contingency, the appraisal contingency, and, in some cases, the financing contingency.
If a home sale fails because of the failure of one of these things – if, for example, the sale falls through because the home fails to appraise for the price the buyer and seller agreed upon – the buyer’s earnest money will be returned and the transaction cancelled. However, if the buyer withdraws for any other reason, including allowing a contingency’s deadline to pass without action, the earnest money will be forfeited to the seller.
Pay attention to all of the deadlines and contingencies in your purchase contract, and make sure to communicate with your agent or attorney if you have any questions about whether a contingency has been satisfied.
Fraud
The second major risk to the buyer’s earnest money is an escrow fraud scheme. Cyber-criminals can email wire instructions that appear legitimate, but are in fact directed to a fraudulent account.
To avoid such a scam, pay attention to the email and website addresses of any instructions you receive, and always reach out to your real estate agent, attorney, or title company to confirm any wire instructions you receive. Never wire money directly to the seller or the seller’s representative.
Buying or selling a home is complicated, and sometimes it seems like you need to learn a whole new vocabulary just to understand what’s going on! But you don’t have to navigate the ins and outs of the earnest money and escrow process alone.
Learn More With Your Trusted Title Company
If you have questions about how your earnest money deposit works, what it involves, or the risks associated with escrow, Landtrust Title Services can help. Landtrust Title was established to fulfill the growing need for partnerships that provide higher service standards and growth opportunities in the title insurance and escrow services industry. At Landtrust, we’re different. We’re customer-obsessed and strive to focus on what you need from start to finish. We strive to deliver service excellence for every real estate transaction. Contact us today at [email protected] or by phone at 312.528.9210 to get answers to all of your questions.