A Guide to Understanding Earnest Money for Prospective Homebuyers
In a competitive housing market, making an offer with your real estate agent that will stand out from the rest is important in securing the deal. Prospective buyers may opt to offer more than the listed asking price, put down a larger down payment, and waive contingencies to make their offer stand out. Many might be wondering one common question: how does earnest money factor into all of this? An earnest money deposit is a more effective way to make your bid more attractive to the seller.
In this article, we will explain what earnest money is, why it is important in the world of real estate, and how you can better protect your funds.
Real Estate: What is Earnest Money?
Also known as a good-faith deposit, earnest money is a sum of funds that you put down to show your commitment to purchasing a house. It will provide the seller with adequate protection and assurance should the buyer back out of the deal or cannot complete the sale. These types of funds are often held in an escrow account until closing on the house commences, and buyers often send their good-faith deposit via wire transfer, a certified check, or a personal check.
Is Earnest Money Deposit a Requirement in Real Estate?
In a short answer: no. An earnest money deposit is not required, but it has become a standard process in the world of real estate transactions. This is particularly true if you plan to purchase within a competitive housing market. If you submit an offer without an earnest money deposit, a seller can make a counteroffer and request one for their peace of mind.
Why Earnest Money is Important in The Homebuying Process
Earnest money has two main purposes: it makes the buyer's offer attractive, and it protects the seller against lost money. When a seller accepts your offer, you will then enter into a purchase agreement, the home will be taken off the market. If you should back out of the deal, the seller will relist the property and start the process all over again. This is both costly and time-consuming. An earnest money deposit will show sellers you are committed to going through with the sale. If you change your mind for any reason, the seller can keep the earnest money deposit.
What is the Appropriate Amount of Earnest Money to Offer?
Earnest money is between 1% to 3% of the sale price. A large good-faith deposit can demonstrate a significant commitment to purchase a home, but factors can influence how competitive your offer is.
How Earnest Money Deposits are Managed
After the buyer and seller agree on the terms of a home sale, the purchase agreement should outline the specifics of how the buyer's earnest money deposit is going to be managed. This will include where the earnest money funds will be held and the conditions under which the buyer's good-faith deposit will be refunded or forfeited. The agreement can also specify deadlines and disclosures, and contingencies that have to be met to finalize the deal.
What Happens to Earnest Money if the Deal Falls Through?
Depending on the contingencies set in place by both parties, established in the purchase agreement, earnest money can be forfeited or refunded to the buyer. If the buyer backs out of the sale that was not highlighted within the contract, the earnest money can be refunded. If not, the seller is within their rights to keep the funds.
Tips to Protect Your Earnest Money
- Make the Purchase Agreement Clear: Include contingencies and/or stipulations that have to be met for you to buy the home.
- Work Closely with a Professional Real Estate Agent: Putting down earnest money is a big deal, and having a certified expert on your side who can talk you through the process while answering questions you have will make the task all the easier.
- Ensure Good Financing and Mortgage Preapproval: You can secure your home's financing and get a mortgage preapproval before making an earnest money deposit. If you are going to be submitting an earnest money offer without securing a home loan, you stand chance to lose your deposit if the sale falls through.
Conclusion
Earnest money goes toward the down payment and closing costs after the purchase agreement is signed. These particular funds are held in an escrow account until closing. Not to be confused with a down payment, this type of deposit will compensate the seller should the buyer break contract and back out, or be refunded should the buyer back out for reasons highlighted in the contract. We advise working closely with a trusted real estate professional to guide you through the process from the initial earnest money deposit to closing and getting into the house of your dreams.
For more information on Durango, Cortez or Dolores CO real estate, give us a call at any time.