Buying a Home:
Making an Earnest Money Deposit

When making an offer to buy real estate you generally include an "earnest money" deposit.  This deposit lets the seller know that you are making an offer in good faith.  In other words,  you are "earnest" about buying the property.  Now, how much should you put forward in earnest money?  And how can you ensure that your deposit is safely held and credited to you at closing or returned if your deal falls through?  Let's take a closer look at earnest money deposits to address these questions.

How much earnest money is enough?   Generally speaking, you want your deposit to be large enough that your offer is taken seriously, but you do not want it to be so large that you put significant funds at risk.  Although most real estate deals successfully close without major problems, there is the off chance that an exception could occur.  Therefore, the smaller the amount you have tied up and at risk in a deposit, the better.

Real estate professionals suggest that your deposit be anywhere from one to five percent of the purchase price.  Where your deposit falls in that range depends on other elements of your offer as well as local market conditions.  For instance, if your offer is close to the asking price, you are pre-approved for a loan, and your offer does not have any unusual contingencies, a seller may be inclined to consider a smaller earnest money deposit. If your offer is not as strong, a larger deposit might be desirable.  With respect to market conditions, if you are in a hot sellers market and the property has attracted a lot of interest, a substantial earnest money deposit could make your offer stand out among those from competing buyers.

Who holds your earnest money deposit?  Once you and the seller have mutually agreed on the terms and conditions of the offer, your earnest money should be deposited and held in a trust or escrow account, not held by the seller.  When working with a real estate agent, earnest money is typically deposited into an escrow account held by the seller's broker, but this varies with location and can be negotiated.  Other potential third parties include title insurance companies, escrow companies, and escrow attorneys.

What happens to earnest money if your deal falls apart?  Typically, if you are not at fault for the deal falling through, your earnest money comes back to you.  For example, your deal may not close because one or more of your contract conditions could not be met.  Maybe you were unable to obtain financing or perhaps the property did not pass inspection to your specified satisfaction.  On the contrary, if you back out of the deal for a reason not stated in the contract, you just might forfeit your deposit.

What happens to your earnest money if you do not close the deal is ultimately determined by the terms of the purchase contract.  That is why it is so important that you ensure your offer stipulates the terms for a refund of your deposit if the deal falls through.  Make sure it covers all of the "deal breaker" conditions you can think of that would be associated with a return of your earnest money.  If you are working with a real estate agent, that person can help you include wording in your offer that describes what happens to your earnest money if the deal does not close.  If you are buying on your own, an attorney can help ensure that your offer is written in a manner that protects your rights to the deposit.  Regardless, you want to know how and when your earnest money is deposited.  And you should be sure to get the facts about state law and even local customs on refunds of deposits before your earnest money leaves your hands.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.