Earnest Money - what, why, how much?

By
Real Estate Technology with Zillow
Earnest Money – whenever we’re writing up an offer for a buyer, invariably the one thing that generates the most questions is earnest money. What is it, why do I need it, how much, will I lose it – these questions almost always require a lot of discussion and education.

What is earnest money and why do I need it? The “book definition” of earnest money is: “A deposit paid by a buyer to a seller to demonstrate intention to complete the purchase.”

That pretty much sums it up. In Arizona real estate, earnest money is some amount of money, deposited in escrow, which helps show the seller that a buyer is serious. Normally the earnest money is applied to the buyer’s down payment at close of escrow.

Without earnest money, and the possibility of losing it, there is nothing to stop a buyer from submitting offers on multiple properties. Without earnest money, there is nothing to stop a buyer from just walking away from a contract days or weeks after it’s been accepted and the seller has taken their home off the market. Sellers want and need to know that a buyer is serious about the offer on their property.

How much earnest money do I need? The simple answer is, “the more the better”. The complicated answer (and one that’s virtually impossible to know in advance) is, “whatever it takes to make the seller know you are serious”. **Generally** speaking, 1% of the offer price is considered a reasonable amount. But like anything in real estate, there are no hard and fast rules. I’ve seen offers written with as little as $1 earnest money and as much as 100% of the sales price.

An example may be helpful here. Let’s say a seller gets two offers. They are identical in price, down payment amount, close of escrow date, etc. But offer #1 has a higher earnest money deposit than offer #2. Regardless of the true motivation of the buyers, the seller will most likely accept the offer with the higher earnest money amount. A significantly higher earnest money amount may even make a seller consider one offer over another even is there is difference is terms such as price, close of escrow, etc. Higher earnest money amounts signify to sellers that a buyer is serious and more likely to close the transaction.

Can I lose my earnest money? The short answer is yes. The complete answer is maybe. Again, generally speaking, your earnest money is “safe” unless you default on the contract. Should the seller default, your earnest money will be returned. In Arizona, the typical “inspection period” (or “due diligence” period) is 10 days. If the property you make an offer on doesn’t “pass” inspection, or if the seller declines to do requested repairs, the buyer can cancel the contract and get their earnest money back. There are also contingencies in the standard residential resale contract that a home must appraise for the asking price and the buyer must be able to secure financing. If neither of these contingencies are met, then generally earnest money is returned to the buyer.

Most earnest money is lost when the buyer backs out after the inspection period. In this case, the seller will almost always retain the buyer’s earnest money.

There’s nothing to be afraid of with earnest money. If you are serious about purchasing a home, you need to indicate to the seller you are serious. They’ll be taking what is probably their single largest asset off the market if they accept your offer. They need to know you are serious about completing the sale. That’s why a seller wants to see that you can get a loan, that you aren’t “fishing” with multiple offers, and that you aren’t going to back out at the last minute. A reasonable earnest money deposit helps reassure the seller you are serious about buying their home.

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Rainmaker
405,516
Simon Conway
Orlando Area Real Estate Services - Orlando, FL
Now another thing you need to be wary of is con artists! I just took a listing from a client who two months ago became interested in purchasing a business. His agent (not me) told him it would be perfectly ok to write the binder check to the listing agent PERSONALLY. When the deal fell apart, the listing agent had spent the $20,000!
Jun 29, 2006 01:14 PM #1
Rainmaker
1,108,786
Jay Thompson
Zillow - Seattle, WA
Yikes... I've heard of those things happening. Sad...
Jun 29, 2006 04:08 PM #2
Rainer
16,816
Bob Crain
Crain Realty - North County Luxury Homes - San Marcos, CA
San Diego County Real Estate Broker
Go to Jail, Go directly to Jail, and don't pass Home! Was this guy thinking he was playing Monopoly?
Jul 02, 2006 05:24 PM #3
Rainmaker
405,516
Simon Conway
Orlando Area Real Estate Services - Orlando, FL
Having spoken to NAR's legal hotline, the result is this. Automatic license revocation, probably going to jail (felony because of the amount involved) AND...I managed to get my client his money back! YAY!
Jul 04, 2006 02:00 AM #4
Ambassador
896,096
Kristal Kraft
The Berkshire Group Realtors - Denver, CO
Selling Metro Denver Real Estate - 303-589-2022

Oh that is scary!  I can't imagine that happening, but I guess it is possible.

In Colorado we require earnest monies be held in a trust account.  I prefer letting the Title Company hold the check instead of some little unknown brokerage.

Better safe than sorry.

Jul 13, 2006 04:58 AM #5
Rainer
41,106
Timothy Butterworth
Taking a break - Portland, OR
This is a great blog, thank you for putting this up.
Sep 06, 2006 08:08 AM #6
Rainmaker
1,108,786
Jay Thompson
Zillow - Seattle, WA
Had to drop a commentathon comment on my first AR blog!
Dec 14, 2006 04:27 PM #7
Rainmaker
394,850
Elizabeth Cooper-Golden
Huntsville Alabama Real Estate, (@ Homes Realty Group) - Huntsville, AL
Huntsville AL MLS

Jay, Is this your first post?  You did a GREAT job.  How exciting, knowing you are the first AR member to write...My hat goes off to you.  Thanks so much for spending time with all of us today on RAIN Radio.  I really appreciate it:)

Dec 11, 2008 06:23 AM #8
Ambassador
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Tammy Lankford,
Lane Realty Eatonton, GA Lake Sinclair, Milledgeville, 706-485-9668 - Eatonton, GA
Broker GA Lake Sinclair/Eatonton/Milledgeville

Well I had to drop in and see what the first blog post by a grandfathered member was all about.  Now after reading brads post and billion comments I have got to get to sleep.

 

Feb 16, 2009 04:32 PM #9
Ambassador
794,068
Brad Andersohn
Director of Education & Industry Outreach at eXp Realty & RE Tech Campus - Fairfield, CA
ActiveBrad - 707.646.1876

We hit 1,000,000 blog posts today Jay,

thanks for starting us off and sending us down the right road.  I gave you a shout out, check it out.

activerain.com/blogsview/1001018/ActiveRain-Hits-1000000-Blog-Post-Articles

Mar 24, 2009 09:47 PM #10
Anonymous
Anonymous

I just learned of the 1,000,000 post, which you made possible by starting with this one ... and wanted to congratulate you.  I think AR should feature this post ... just because.... :)

What do you say, Brad? 

Mar 25, 2009 12:11 PM #11
Rainer
73,623
Lonn Dugan
Toledo, OH

Brad Has Heard The Cry From the Valley, and The spotlight is on! 

Jay is Genius, Tireless, Self Admittedly Opinionated, and even - on occasion - 2 Phunni!

Jay has made a wonderful contribution to the world of real estate as well as the blogosphere and I salute him.

 

Apr 08, 2009 12:14 AM #12
Ambassador
533,574
Kate Elim
Dockside Realty - Spotsylvania, VA
Realtor 540-226-1964, Selling Homes & Land a

Hi Jay...Your post is as relevant today as it was on June 25, 2006. 

Another contingency where the buyer can receive their earnest money back is when they receive the Property Owner's Association package, even if it is the day of settlement, and if they say they have a problem with it.  Many homes and, of course, condos are in a POA.  In Virginia you must have three days to review the contents unless you waive the time period or receipt altogether.

Thanks for being a great leader.  Your post is exactly what is beneficial for us at Active Rain.  It is not only a good reminder to agents but is important information for the consumer.

Kate

Mar 29, 2010 08:00 AM #13
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