If you’ve purchased a home or even offered to purchase a home, you know that you handed the real estate agent a check for an earnest money deposit. But why?
The earnest money does just what the name indicates. It shows that you are in earnest as a buyer. You have, in effect, “Put your money where your mouth is.” Few sellers would even entertain an offer that didn’t include earnest money.
The amount of your earnest money will depend largely upon standard practices in your state and upon what the seller requires before he or she will consider an offer. In Texas, earnest money is typically about 1% of the price you are offering for the home.
In markets where competition for houses is stiff, sellers may ask for as much as 2% or 3% earnest money. Additionally, agents sometimes recommend offering more earnest money as an incentive to the seller to strongly consider your offer or even to negotiate on the price.
Earnest money, also known as a good-faith deposit, is not simply another expense. It is an advance payment on the funds you’ll be required to present at closing. In other words, it is an advance on your down payment and/or closing costs.
Where does the earnest money go after you give it to your agent?
Earnest money goes into a special bank account called a trust account. Depending upon local practices, the trust account could belong to a title company, the real estate agency, or an attorney. Here in Texas, earnest money is held by the title company.
Earnest money stays in the trust account until closing, when it is transferred to the closer to be added to the buyer’s closing funds and disposed of in keeping with the purchase and sale agreement.
Note that buyers should never give their earnest money directly to the seller, even if no real estate agents are involved. It should always be held in a secure account by a third party.
Sometimes purchase transactions fail. What happens to the earnest money then?
Disposition of the earnest money from the trust account will depend upon the reason why the transaction failed. If you want your earnest money back, there does need to be a valid reason why the transaction failed. Changing your mind is not one of them.
Competent agents will help buyers write purchase offers that protect them from losing their earnest money if they are unable to obtain financing or unable to obtain clear title. The agreement may contain other contingencies, such as acceptance of any problems found through the property inspection, an appraisal for at least the purchase price, or buyer’s acceptance by a Homeowner’s Association. Buyers’ agents generally know what issues might affect a given property and should protect their buyers by including relevant contingencies.
When competition for houses is fierce, agents sometimes advise buyers to include as few contingencies as possible.
Note that a low appraisal will not protect the buyer’s earnest money unless it is specified in the agreement. The financing contingency should allow buyers to renegotiate the purchase price or get their earnest money back. It should also specify the maximum interest rate that a buyer will pay to obtain the mortgage loan.
In the event that there is a dispute over disposition of the earnest money, the entity holding that money will continue to hold it until the matter goes to mediation – or even to a lawsuit. This is one reason why some agents advise their buyers to deposit the least acceptable amount.
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