Earnest Money 101
Earnest money is the buyer's way of letting sellers know that he or she is serious about buying a home. Earnest money is a sign that buyers are willing to put their money where their mouth is. Often the amount of earnest money is unimportant. In other cases, the more earnest money offered to the seller, the better.
How do you know how much to offer?
A good rule of thumb to follow with earnest money is to never offer more than a liquidated damage clause will cover. In most areas, buyers and sellers sign a purchase agreement at the time that an offer is accepted. These agreements usually include a clause stating the percentage of the purchase price that can be claimed in damages by the seller should the buyer cancel the sale for any reason. This protects the buyer from having to fight for reimbursement if he or she has offered more than the standard 3% in earnest money.
The story is different in a seller's market.
The 3% calculation is a safe bet for both parties, but the rules change quickly in a seller's market. Sellers often receive several competing offers on their home. They need to determine which buyer is the most serious buyer and they often judge this by the amount of earnest money offered.
Earnest money is NOT a down payment.
If you are new to the home-buying process, you may not realize that the earnest money you offer is not a part of your down payment. Rather it is a payment made to let the seller know that you want to buy his or her home. You do not give the money directly to the seller. In most cases, the funds are returned to the buyer so that they can be used toward the closing costs.
Give the earnest money to a trusted third party.
In today's day and age, you need to know where your money is going and protect yourself from theft. Unfortunately, people are not always who they claim to be. Make an earnest-money deposit with a known real-estate brokerage firm or an attorney who agrees to place your deposit in a temporary trust.
Get a receipt for your earnest-money deposit and ALWAYS ask questions before making the deposit. These questions should cover the refund policy and when the money will be released.
Know the local laws.
You cannot be expected to know every little rule about real-estate transactions in your area. Therefore, work with a realtor who knows the area and the applicable rules. Some topics to research include return policies, damage clauses in the event of cancellation, and release procedures. These all vary by location.
Some areas require the signatures of both parties before earnest-money funds can be released to either party. With a successful sale, this is rarely an issue and the money is released to the appropriate party at the specified time. However, if the contract is canceled or if a dispute arises, this requirement could cause trouble.
Summary
Research the area to which you are planning to move before determining how much earnest money you will offer. Never give that money directly to the seller. It is important to work with a licensed realtor to protect your interests and make your home-buying experience as successful as possible. Avoid hassles and unnecessary worries by learning more about what you are required to offer in earnest money and how the deposit needs to be structured to best protect your interests.
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