Whether you pay in cash or get a mortgage to buy your first home, you’ll be required to present an earnest money deposit. Sellers take it as proof that you are a serious buyer and doing the transaction in good faith.
Let’s define earnest money deposit
An earnest money deposit is a fraction of the purchase money put in escrow after a seller accepts a bid to buy a home. It’s also called a good faith deposit to show the buyer’s willingness and commitment to successfully consummate the sale.
This deposit is not to be confused with the down payment, although the funds can go toward it or the closing costs at the close of the loan. The earnest money which is usually paid via check or wire transfer is made within days of the seller’s receipt of your offer.
With the amount in an escrow account, you are effectively buying time to finalize financing to close the transaction. This bar is higher for cash buyers because they might have to come up with a bigger earnest money to show their capacity to pay in cash.
Each real estate market goes by its local practices regarding how earnest money deposits are done.
The question is: how much is it?
Taking into consideration varying practices, the earnest money deposit can be a percentage ranging from 1% to 3% or 3% to 5%, depending on the market. If it’s a sellers’ market, the amount can be larger to make it more enticing than other offers.
The deposit can also be a fixed amount, e.g. $1,000. This sometimes applies to buyers who are using VA loans with 100% financing (thus no down payment) and making minimal down payments (e.g. FHA loans with 3.5% minimum down payments). Again, consider the practices of the local housing market where you are buying the home.
More importantly, can you get it back?
You and the seller will enter an earnest money contract or an earnest money escrow agreement that sets forth:
- the amount to be deposited with the escrow agent as earnest money
- the amount in all to be deposited as down payment
The amount will be held in escrow until the closing date. But the agreement also states the conditions of the release or forfeiture of the funds if the transaction falls through.
For example, you could lose the deposit if you back out of the deal or fail to meet certain conditions of the seller. Assuming the reason for backing out the deal is allowed in the contract, you could be refunded the amount. It’s thus important to go over the terms of the agreement before signing it.
State laws govern the purchase or sale of the property, including the escrow agreement. If a dispute arises between you and the seller, the funds could remain in escrow until such time as the dispute is resolved or adjudicated by the small claims court like in North Carolina.
To protect yourself and your deposit, hire a reliable real estate agent or brokerage firm to hold the earnest deposit until the consummation of the transaction. You can also engage title companies that offer escrow services or real estate attorneys for that matter.