It is not unusual for people to confuse a downpayment required for your mortgage and an Earnest deposit. They both go towards the amount due at closing but are very different. As such, I wanted to make sure that buyers have a clear understanding of what an Earnest Deposit is and how it works.
The point of the earnest deposit is to show good faith from buyers that they are serious about purchasing the home they are putting an offer in on to help a seller decide if it is worth accepting the offer and removing their property from the market until the buyer commits to complete the purchase and remove all contingencies on closing. For this reason, it’s unusual for a seller to entertain an offer on their house without it being backed up by a deposit that a buyer has put up with the offer.
If the sale proceeds successfully to closing, the earnest money can be used for the down payment or the closing costs of the sale. It can be looked at by buyers as putting aside some funds to cover part of these later costs.
Since it is a deposit, it does mean that there are many situations that allow buyers to reclaim these funds when things don’t go according to plan.
How Much Should a Buyer Offer in Earnest Money?
This can vary by price point and geography. Before moving to Naples, I found the typical the earnest deposit a buyer would provide to be between 1% and 5% of the purchase price. There are a few factors that can affect this, however, including the state of the real estate market and what the seller requests as a deposit. In Naples, I have seen this amount come in closer to 10% as a standard. Of course, every offer is different and there is not hard and fast rule. It is just helpful to understand what sellers are accustomed to for our area.
You should determine your earnest deposit in consideration of your other offer components as well as the competition for properties such as the one you wish to make the offer on. Sometimes putting down a higher deposit could lead to the seller being more flexible on other terms in the offer.
What Happens to the Earnest Money Deposit?
When an offer has been accepted, a purchase agreement for the house will be executed. This agreement states who is going to be holding the deposit (escrow agent). In Naples it is almost always either a Title Company or a Real Estate Attorney, who will keep it in their escrow account. The earnest money will be accounted for at the time of the closing.
How Do Earnest Money and a Down Payment Differ?
Quite often, buyers get confused about the difference between earnest money and a down payment. While they both contribute to the purchase price of the house, the earnest money is security for the seller, while a down payment is money a buyer has to put towards the purchase price. The balance of a buyer’s funds for purchasing a house will come from the procurement of a mortgage.
Is It Possible to Get an Earnest Money Deposit Back?
There are many situations that will allow purchasers to get their earnest money deposits back. The determine factor will be whether the buyers had a contractual right to terminate the purchase agreement. As such, the contract should always be reviewed prior to signing and prior to terminating.
There are often contingencies in the contract to allow for situations where the buyer can walk away with their deposit returned to them. Common contingencies would include a seller not being willing to address non-working systems/equipment found in the inspection process or the buyer failing to secure financing for the purchase price. If there are any questions regarding contractual rights, we always encourage parties to consult with an attorney specializing in real estate.
Can You Lose Your Earnest Money Deposit?
Buyers do not have the right to cancel purchase contracts for any reason. Cancelling a contract to purchase after a home is removed from the market is a hardship on the sellers. Depending on the reason for the termination, buyers may forfeit their earnest money when they don’t pay attention to the terms of the contract.
Here are the most common ways buyers can lose their deposit:
Money on the line is nothing to take lightly and one of the many reasons you should consult with an experienced, knowledgable real estate professional to help you.
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