Earnest money is a term used to refer to an amount of money given by a buyer to a seller to demonstrate the buyer’s good faith in the transaction. Most commonly used in real estate transactions, earnest money may be used to allow the buyer more time to seek financing, or come up with the rest of the money. Unlike a simple deposit, earnest money is not solely held by the buyer, but put into an escrow or trust account held by both parties. To explore this concept, consider the following earnest money definition.
Definition of Earnest Money
- A sum of money given to a seller in order to bind a contract, or as a show of a buyer’s good faith in his intent to finalize the deal.
What is Earnest Money
Earnest money is a way for a buyer to prove to a seller that he is serious about making the purchase in question. It provides the seller with incentive to continue with the transaction and wait for the buyer to secure the necessary funds. Earnest money, also known as a “deposit,” is put toward the down payment when the sale is finalized. However, if the sale does not occur for any reason, the buyer may be forced to forfeit the earnest money. This is especially true if the transaction is called off due to no fault of the seller.
Earnest Money Deposit
In many cases, a buyer can expect an earnest money deposit to be at least 1percent of the purchase price, though sometimes the rates are as high as 2 to 3 percent. Some of the factors that influence the amount of earnest money include:
- Current state of real estate market. If homes are selling quickly, the seller may require a higher deposit amount, and vice versa.
- If more than one buyer has bid on the property, the bidder offering the highest earnest money amount may secure the agreement.
- The overall price of the home.
Request for Higher Earnest Money Deposit
The amount of earnest money required is generally negotiable, and must be agreed by the parties prior to signing a Purchase Agreement. While the buyer can offer an amount, it does not have to be accepted by the seller. Earnest money deposits have a broad range of anywhere between $500 and $5000 or more, though a seller may ask a higher amount in circumstances such as:
- The buyer has requested a closing date further into the future
- The buyer is asking for zero down or a low down payment
- The seller has other offers or sees an increase in interest in the property from others
- The buyer is willing to pay a higher earnest money amount
The Earnest Money Process
After a seller accepts an offer, the buyer is required to sign a contract called a Purchase Agreement. This begins the earnest money process, entering both parties into a legally binding agreement for the purchase of the home at the terms agreed upon. After the agreement is signed, the buyer provides an earnest money deposit to be held in an escrow account by the real estate broker or a title company. When all provisions of the sale are complete, the money is released to the seller as part of the purchase price.
If the buyer finds he is unable to find financing for the purchase, he can usually get his earnest money back, though this depends on the exact wording in the Purchase Agreement. Earnest money should never be given directly to the seller, as the creation of an escrow account by a third party agent helps ensure proper distribution of monies at the conclusion of the deal.
Earnest Money Agreement Form
When making a real estate purchase, most often the parties will sign a standardized contract, the language of which varies by state. Real estate brokers and agents should have the correct real estate earnest money contract forms, and consumers may obtain them from their local real estate commission office or website. While certain statutory language varies, all real estate purchase agreements include transaction-specific information, such as:
- Identifying information for both buyer and seller
- Total agreed purchase price
- Amount of earnest money paid
- Estimated closing date
The earnest money agreement form should also contain stipulations and warranty information made between the parties, if any apply. Both parties should read the real estate earnest money contract carefully before signing. Because some of the information in a real estate contract may be difficult to understand, a qualified real estate agent or attorney may be used to walk the buyer or seller through the process.
Earnest Money Refund
Earnest money is a deposit made as part of a purchase contract, so the chances of a buyer getting it back depend on the conditions under which the contract is cancelled. Often times, the Purchase Agreement signed by the parties will specify whether or not release of earnest money is possible, what percentage of it is refundable, and the conditions that must be met for the buyer to receive a refund. The agreement will also outline the intentions and requirements for both parties in the real estate transaction.
For example, most agreements stipulate that the sale is contingent upon buyer being approved for a mortgage or other type of loan by a specified date. Such agreements usually state that, in the event the buyer fails to obtain financing by that date, he is entitled to a refund of his earnest money deposit. Refundable earnest money may be reduced by the amount of third-party fees, such as the cost of an appraisal or inspection.
It is possible that the Purchase Agreement states that there will be no earnest money refund for any reason, making the careful reading of all terms of the agreement extremely important. Such terms are always negotiable, and may be changed on the contract prior to signing.
Protection for Buyers
It is best for buyers to have the house in question inspected before signing any agreements or making an earnest money deposit. An inspection provides protection for buyers, making them aware of any problems that may not be readily noticeable. If a buyer signs a Purchase Agreement without being aware of the true condition of the property, he may be stuck in a contract for purchasing a house he doesn’t want. While there is no way to force a person to buy a house or piece of property, the seller can force the terms of the Purchase Agreement, in which the buyer may forfeit his earnest money deposit by breaching the contract. There are certain methods of protection for buyers, including:
- Paying an option fee gives the buyer the right to walk away from the deal at any time, for any reason. Taking an option to purchase a property is ideal from the buyer’s standpoint, as it takes the property off the market for a specified period of time, allowing for such activities as inspection and loan seeking. Not all sellers are willing to give a purchase option.
- Specifying repairs to be made in the contract makes the purchase contingent upon specified repairs to be made by the seller. The making of repairs is an option that may be negotiated with the purchase price, depending on what the parties want. Such negotiation must be made prior to signing a Purchase Agreement, the specifics included in the agreement.
- Including a lender-required repairs clause allows the buyer to withdraw from the agreement if repairs required by the lender exceed a certain amount, usually 5 percent of the purchase price. This clause is a requirement in many states, though not all. If not required, it can be negotiated into the contract.
The Title Company
Real estate transactions are complex, with many requirements for proper transfer of the property, inspections, contracts, and money changing hands. The job of a title company is to keep track of all necessary documentation, as well as the money, letting the parties know when every element has been satisfied and the purchase can be finalized. The title company then makes sure all the documents are filed with the correct governmental agencies, and the money correctly distributed between the parties and their agents.
The title company is also responsible for checking to be sure that the property’s title is clear and unencumbered for transfer, for which they issue a title insurance policy guaranteeing the buyer isn’t buying a property on which others may have claim, such as a lien. Using a title company is not required, and they do charge a fee, but it makes a complicated process much easier and helps assure it is done correctly.
The title company is chosen jointly by the parties, before which both parties should ensure it has a solid reputation. In some cases, the mortgage lender will insist upon dealing with a particular title company, as they have a history of working together.
Breaching a Real Estate Purchase Contract
After a Purchase Agreement is signed, it is considered a legally binding contract, and both parties are required to fulfill their obligations. When a transaction fails, it can cost both the buyer and seller time and money, even in the early stages of the purchase process. When a party to a contract fails to fulfill his obligations, or “breaches” the contract, the other party may file a civil lawsuit for the breach. Because the prevailing party is often required to pay the other party’s legal fees, it is usually in the best interest of both parties to avoid breaching a real estate purchase contract, or to negotiate a settlement on their own.
Related Legal Terms and Issues
- Real Estate Agent – A person licensed by the state to represent buyers or sellers in real estate transactions in exchange for a commission.
- Real Estate Broker – A person who has received an education beyond the level of real estate agent, and is licensed by the state as a broker. Brokers may work alone to represent buyers or sellers in real estate transactions, or may hire real estate agents to work for them.
- Binding – Having power to bind or oblige; imposing an obligation.
- Civil Lawsuit – A lawsuit brought about in court when one person claims to have suffered a loss due to the actions of another person.
- Contract – An agreement between two or more parties in which a promise is made to do or provide something in return for a valuable benefit.
- Default – Failure to fulfill an obligation, or to appear in a court of law when summoned.
- Obligation – A promise or contract that is legally binding; the act of binding or obliging oneself, as in a contract.
- Performance – The act of doing that which is required by contract.