What, when and how much is Earnest Money?

Earnest Money!  What is it? How much is it? Is it the same as downpayment? Do I get it back? When do I have to pay it? Will my check be cashed? Can I lose it? Aw the questions are endless. 

It's one of those issues when buying a home that can generally cause a lot of confusion and misunderstanding, so I'm going to try and explain what it is, when it needs to be paid and how much it is. However I strongly suggest that you consult with your own Texas REALTOR so that your particular home buying needs can be address.

Earnest Money. What does that mean?

To be earnest is generally understood as an intense and serious state of mind. Or when treated as a noun, it's defined as follows. 

So when used in a real estate transaction Earnest Money represents a sincere deposit made by the home buyer to the home seller in order to move forward with and bind a purchase contract.

I can hear you now: What? You mean in order for me, the home buyer, to be able to buy a house, I have to pay the home seller some money up front just to make an offer? 

Well sort of.

First of, you can make an offer and have it presented to the seller without having actually written the check. However, as stated in the above definition, Earnest Money is a token of some value given in order to secure a binding contract. The money doesn't actually go directly to the home seller but it is instead held in escrow (usually a title company or attorney that both parties agree upon) and it is generally applied towards the buyers downpayment at closing. It is a way of showing the home seller that you are a serious buyer with every intent on completing the transaction.

After all you are asking the home seller to take their property off the market for several weeks until the closing occurs and by depositing earnest money in escrow you are showing a willingness to put your money where your signature is.

When do I have to pay Earnest Money?

Once you have a fully executed contract the Earnest Money check is due. It's a check made payable to the agreed upon title company or attorney. This check will be deposited in an escrow account on your behalf so make sure it's written on good funds. Failure to provide the earnest money check will cause you to be in default on the contract.

How much is the Earnest Money check for?

The amount of earnest money paid is an amount that is agreed upon by both the buyer and the seller. There are no hard and fast rules when it comes to Earnest Money amounts but generally speaking it can be 1% of the sales price. This is just a guideline amount but it will give you an idea of what to expect.

I will note that whenever I represent a home seller, I try to get as high an earnest money amount as possible. This is because if a buyer defaults then the earnest money generally goes to my seller. More on that next.

What happens to the earnest money if I decide not to buy the house?

If you decide that you don't want the house or if for some reason the house does not appraise and you can't get financing for it then you can get your earnest money back.

However and this is a huge HOWEVER, if you are in default on the contract then most likely you will not get your earnest money back but instead it will be given to the home seller.

There are several safe guards in place throughout the purchase contract to protect both you and the home seller.

So before you panic, let me go through a couple of those safety nets.

First there's the option period.

This is an agreed upon period of time that begins on the day after the contract is fully executed and ends at mid-night after an agreed number of days. During this option period time, one of several things that a home buyer can do is reserve the unrestricted right to terminate the contract without cause. This is an incredibly powerful right and it should not be taken lightly. Therefore if you choose to exercise this right, proper notice needs to be given to the home seller and it must occur within the option period time frame. You will then, I'm happy to say, get your earnest money back. 

Secondly, there's the Third Party Financing protection.

If you are financing your home purchase your lender will have lots of different requirements. If for some reason, either you the buyer are not approved by the lender for financing or if the property itself doesn't pass the lender smell test then you have the opportunity to terminate the contract with effective notice to the seller in the time frame allowed and you will receive your earnest money back.  

It's important to note that under either one of these protections, you can only be sure of getting your earnest money back if you provide effective notice to the seller within the time frame required. (Here's where working with a really good buyer agent kicks in) otherwise you will be in default. In that case most likely you will NOT get your earnest money back and worse yet you could be sued by the seller for specific performance. 

Who decides if I get my Earnest Money back?

Ideally, both parties would agree as to who gets the Earnest Money back. There is a simple one page form that would need to be agreed too and signed by both parties authorizing the title company that is holding the earnest money in escrow to release it to the appropriate party.

There are several terms in the Texas Real Estate Purchase Contract that specifically state that in the event of certain situations and provided X,Y and Z happens, the Earnest Money will go back to the buyer.

However, as we all know, there are times that the lines can get a little blurred.

In that case both parties are required to participate in mandatory mediation to resolve the dispute prior to going to court.

Again, I cannot stress the importance of discussing Earnest Money and contract requirements with your Texas REALTOR and/or attorney. An executed contract to purchase real estate is a legally binding document with a lot of money on the line. So don't take any chances of losing that money by not fully understanding the requirements and purposes for the money. 

Happy house buying.