Earnest Money Deposits: Do You Need Them?

Earnest Money Deposits

When you submit an offer on a home, your agent may recommend making an earnest money deposit. It is a very common thing to do when you find the perfect property and do not want to lose it. If you’re nervous or looking for more information on earnest money deposits, we’re here to help.

This post will:

  • Help you understand earnest money deposits.
  • Explain when you should make one.
  • Share how earnest money deposits can help your home buying experience.

What is an Earnest Money Deposit?

An earnest money deposit is an amount of money you pledge to a seller if that seller accepts your offer. The deposit shows that you are ready to commit to the sale and aren’t going to back out after your offer is accepted.

If the seller accepts your home offer, and you don’t hold up to your end of the contract, the seller keeps the earnest money deposit. This money is not given to the seller immediately. Rather, it’s held in a third-party escrow account until closing.

A seller takes a risk by accepting your offer due to the steps of the home-buying process. By making an earnest money deposit, you’re demonstrating that you’re also willing to take a risk. The deposit helps establish a higher level of trust between both parties, which is advantageous to you.

For example, a higher offer than yours may be in place with no earnest money deposit. But because your offer includes the earnest money deposit, it will appear more legitimate. The deposit can help you get the home without making a higher offer because the seller understands that you are legitimately ready to commit to the purchase.

Keep in mind that if your offer is not accepted, you do not need to commit to the money you’ve pledged to the seller. Also, it’s not an additional cost you add to the money you must bring to closing. The total amount of the earnest money deposit is subtracted from your expected down payment. It is your money until the deal is made unless you back out of the sale with no legal reason. In that case, it is rewarded to the seller.

How much does it cost?

The cost of an earnest money deposit depends on the home’s selling price. Think of it as a much smaller down payment. It is typically the equivalent of 1-3% of the offer. For example, if you are making an offer on a property for $200,000, your earnest money deposit would be anywhere from $2,000 to $6,000.

If a seller isn’t particularly motivated or receives multiple offers, a higher deposit is usually better. This helps show that you are more serious than other potential buyers.

But you don’t always have to make an earnest money deposit. Some sellers are very motivated, and either doesn’t know about a pledge or don’t care about it. And there is nothing that legally binds you to make one. Your agent may simply recommend it because it shows that you are serious about an offer and increases the likelihood of making the sale.

What are the risks with sending earnest money?

Again, there is the potential that the seller can keep your earnest money deposit, and that means there are some risks associated with making one.

The first risk to be aware of is that if something happens in which you are forced to back out of the deal, you can lose your deposit. That is why it is essential to build proper contingencies into your end of the contract, which become the guidelines that legally allow you to back out under given circumstances.

If you do legally back out of the deal, the deposit is refundable. A contract may state it’s only refundable if you back out of the agreement within a given amount of time.

Also, another risk is presented; the contract may give you a set amount of time to secure a loan. If you cannot obtain a loan within the time frame, the deposit may be forfeited.

Otherwise, there is little to be concerned with because it will be considered part of the money you are required to produce on closing. Again, it is not an additional expense, merely a deposit to secure the transaction.

Frequently Asked Questions about Earnest Money Deposits

What types of payments are accepted for earnest money deposits?

An earnest deposit is usually paid with a personal check, cashier’s check, or wire transfer. Cash or credit cards are typically not accepted. Your lender will need a copy of the check or transaction record, and may also ask to see a bank statement to verify the payment was cleared.

Is earnest money the same as a down payment?

No, it is not. It is a small deposit made to show that you are ready to commit to the sale. However, if the offer is accepted, the deposit will be deducted from the down payment.

Do you have to have an earnest money deposit?

You do not need to have an earnest money deposit, but it can be beneficial to you in a competitive market.

Do you lose earnest money if the inspection fails?

This occurs only if you back out of the sale based on a failed inspection with no contingency in the contract.

Can a seller keep my earnest money?

A seller can keep the earnest money if you back out of the contract with no contingency that allows you to keep the deposit. The same is true if the seller rightfully backs out if you fail to meet your end of the agreement.

How long does a seller have to return earnest money?

A seller is not given the earnest money deposit. Instead, it is held in an escrow account until closing, where it is factored into the buyer’s down payment. That is unless the buyer backs out without legal cause.

What happens to earnest money if the loan is denied?

If you fail to secure a loan within the time specified in your contract, the seller can usually keep the deposit.

What happens if a buyer doesn’t pay earnest money?

If the buyer fails to pay earnest money, it will constitute a breach of contract thereby allowing the seller the cancel the agreement.

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