Once you get into the home-buying process you will realize that there are many other expenses besides the down payment and closing costs. One such expense which can come as a surprise and you need to plan for is earnest money. Here is an overview of what earnest money deposit is and its role in the mortgage process.
What Is Earnest Money And How It Works?
Earnest money is an upfront deposit made to the seller to show that you are serious about purchasing the property. It is also referred to as “good faith money “or “earnest payment”. The seller will then take the property off the market. This gives you extra time to move forward with property appraisal, and inspections before closing on the home. The earnest money check is deposited in an escrow account. At closing, this deposit will be used towards your closing costs or the down payment.
The earnest money deposit often ranges from 1% to 3% of the property sales price, but can even go up to 10% if the housing market is hot.
Earnest benefits both the seller as well, as the buyer. It acts as a safety net for the seller if the deal falls off and helps the buyer to cover closing costs. Earnest money can be negotiated and putting extra money can give you an upper hand in a competitive market
Can you get a refund of your earnest money?
During the exchange of earnest money, both the buyer and the seller enter into a purchase contract that sketches out the details of the earnest money as well as contingencies or conditions for refunding the amount. Some contingencies clauses include:
- Home Inspection Contingency: If the home inspection reveals major structural problems or repair issues that the seller will not address or the buyer cannot afford. Then the buyer can walk away from the deal.
- Appraisal Contingency: If the home appraises for lower than the purchase price and if a new price cannot be negotiated, then you can back off from the deal. Your mortgage lender will not give you more than the home is worth.
- Home sale contingency: If you are purchasing your new home by selling your current home, then this allows you a certain amount of time. If you cannot find a buyer then you can back out of the purchase to protect against paying for two mortgages at the same time.
- Title contingency: If a title search reveals problems with the title on the property such as liens against the property or other ownership claims the buyer can get his earnest money refunded.
- Financial contingency: Your mortgage loan falls through or you are facing financial difficulties due to loss of a job or a health emergency. Then you can back out and get your earnest money refunded.
However, the seller might keep the earnest money if:
- You decide not to purchase the home due to certain contingencies that are not listed in the contract.
- You are not able to meet the timeline detailed in the contract to complete the purchase process including the home appraisal and home inspection.
- You changed your mind and decided to drop out of the home buying process
Earnest money is always refunded if the seller decides to cancel the deal.
How to Protect Your Earnest Money Deposit
Prospective buyers need to keep these tips in mind when they pay an earnest money deposit.
- Work with a trusted estate agent: Though you can negotiate the home purchase price or earnest money on your own, working with an experienced agent can be helpful. Your agent will word the contact correctly and add as many contingencies as possible so that there are fewer chances of you losing your earnest money.
- Review the local homebuying market: Discuss with your agent about the market trends around you and what amount of earnest money is customary in your market. This will help you decide how much earnest money you need to put down.
- Determine your budget and financial situation: Before you make an offer on a home and putting down earnest money you should assess how much home you can afford.
- Ensure that all financial and inspection contingencies are included in the contract: If your financing falls through or there is a major defect in the structure of the home your deposit could be forfeited.
- Read the contract properly and abide by the terms: Each contract is different so you should go through it thoroughly and fully understand what you are agreeing to. If your home inspection and appraisal have to be done by a certain date you must meet that deadline. Especially, if the seller puts a “Time of Essence” clause in the contract. Otherwise, you risk losing the deposit and the house too.
- Be careful if you waive any contingencies: Sometimes sellers may request a contingency waiver if they get an all-cash offer or if there are many offers due to a competitive market. However, you should consider the risk before doing so. You will have to get assurance from your mortgage lender that the loan will be approved or hope that there are no major issues with home inspection and appraisal.
If you are a first-time homebuyer you must be aware of all the costs associated with purchasing a home including earnest money. Budgeting for these costs ahead of time will make your home buying journey smoother and stress-free.
If you have started your search for a home and need to know how much home you can afford take the first step by getting pre-approved for free.