Earnest money is an initial payment that a homebuyer offers to a seller in order to sign a purchase agreement letter. Earnest money deposits are fairly common in competitive markets, especially when a seller is concerned that a buyer may make multiple offers on numerous properties.
It may possible to buy a home without putting down earnest money, but it is uncommon, and it is rare that a seller will waive an earnest money deposit.
As soon as an agent or broker accepts an earnest money deposit on behalf of a seller, they become an escrow agent, and the money is placed in an escrow account.
In most cases, when it enters into escrow, the earnest money cannot be released until both parties provide written permission. If a deal falls apart because the home doesn't pass inspection or doesn't appraise high enough, the earnest money will most likely be returned.
The only other acceptable reason to release earnest money funds is under instruction from a court order. This usually occurs if the deal becomes contentious, or there are unforeseen issues.
Earnest Money Deposits
The rules that govern earnest money deposits in real estate transactions vary from state to state. It is common for prospective buyers to set down earnest money equal to 1 to 5% of the purchase price of the home. For example, if you are buying a $400,000 home, you may end up making an earnest money deposit for as much as $20,000, just to show the seller you are a serious buyer.
In most cases, the earnest money, once released, is applied as part of the down payment or used to pay closing costs.
Potential homebuyers are discouraged from giving earnest money in cash directly to a seller, for multiple reasons, namely, it may be harder to get your money back if the deal falls apart.
- Putting down earnest money is a monetary way for you to show your commitment to the purchase of a home.
- Earnest money goes into an escrow account usually held by the real estate broker or the title company.
- If a deal falls apart because the house doesn't pass a home inspection, the earnest deposit is usually returned to the buyer.
- Earnest money may be used towards the closing costs during the actual sale proceedings.
The Release of Earnest Money
There are very few universal rules when it comes to handling earnest money. Instead, the rules are established in the sales and purchase agreement of the home. The agreement covers how refunds are handled—if there is a cancellation fee if the buyer backs out and under what parameters the broker or title company determines if the money is returned.
It is always a good idea for the broker to seek a written release from both parties before releasing the earnest money deposit. If both parties claim the deposit, the broker should not release the funds until the two sides have come to terms or a court order is presented.