The Importance of Being Earnest: All About Earnest Money Deposits

Buyer Protection

Breaking out the checkbook and presenting an earnest money check to the seller shows that you’re a serious contender, and it helps your offer get the attention it deserves.

A solid contract supplemented with an earnest money deposit shows a seller that you have both the resources and the desire to seal the deal. Including a considerable deposit could even help your offer be selected over others.

Keep in mind that as a buyer, you want to gain as many concessions as possible from the seller. The best way to start any relationship is with a showing of good will. An ample deposit serves this purpose, and places buyers in a great position to negotiate more favorable contract terms.

Seller Protection

Buyers stand to lose their earnest money if they jump ship on a real estate transaction. Earnest money gives sellers monetary assurance that a buyer won’t back out of the contract without valid cause.

Most contracts have contingencies that allow buyers to walk away from a home. Two examples are if the house can’t pass inspection or the buyer can’t qualify for financing. But, if a buyer decides to cancel the contract for a reason not covered by a contract contingency, earnest money is generally forfeited to the seller.

How Much Should I Put Down?

The earnest money amount will vary according to your area, seller and price of home you're considering. The best way to determine local customs is to talk to an experienced real estate agent. Your earnest money deposit could range anywhere from a couple hundred dollars to a few thousand. So much depends on the specific property, the competitiveness of the market and other market-specific factors.

A competitive market might mean you’ll need to put down more money. Most agents agree that buyers should include an earnest money amount that will be taken seriously, but not so much that a buyer’s finances are at risk. It’s unlikely that you’ll lose your earnest money deposit, but it’s important to protect yourself.

Your Earnest Money Contract

You’ll typically use a third-party escrow agent such as the title company, to hold your earnest money deposit in an escrow account. You should avoid giving the deposit directly to the seller. If the transaction doesn't close and the seller cannot return the money, you may have to pursue legal action, costing you more. Giving the money to a third party escrow agent protects the buyer from questionable sellers.

The terms of the contract decide where earnest money lands if the contract is broken. Let’s say that a buyer’s contract has made the final purchase contingent on the results of an inspection. If the inspection reveals problems that are unacceptable to the buyer, the buyer can walk away from the home with his earnest money in tow. If the buyer backs out just due to a change of heart, the earnest money deposit will be transferred to the seller. You also need to watch the expiration date on contingencies, as it can impact the return of funds.

Make sure to work with a reputable, experienced real estate agent when crafting your offer. A good contract with proper contingencies is essential in protecting your earnest money deposit.

What are Typical Contract Contingencies?

Backing out of a home loan can be a sticky legal situation. When you signed your contract for the home there were certain contingencies associated with buying the home. Contingencies within many VA loan contracts include:

• Contingent on the appraisal: VA loans automatically protect a buyer's earnest money in the event the appraised value comes in below the purchase offer. This protection is a part of every VA purchase loan.
• Contingent on a home inspection: This contingency allows you to walk away from a home with your earnest money if the inspection reveals unsatisfactory housing conditions.
• Contingent on obtaining financing: This contingency assures that you receive an earnest money refund if you don’t receive proper financing in time.
• Contingent on selling your current home: If you’re unable to sell your house before closing on your new home, this contingency lets you walk away with your earnest money. Many sellers aren't fans of this contingency, given the unpredictable nature of real estate.

These contingencies are designed to keep you safe from the unexpected, and you can negotiate these conditions with the seller before signing the contract. Chances are that getting cold feet won’t be a contingency, so carefully read your contract and know legitimately acceptable reasons for backing out.

How is Earnest Money Used?

Earnest money is paid at the time of your offer. Each state has very strict rules on how this deposit is managed until the transaction closes. Generally, these funds are held in an escrow account managed by the buyer’s real estate agent or the title company. The deposit is then applied to your closing costs or returned to you at closing.

Earnest money funds are usually applied to a loan’s closing costs or to the down payment. Since VA loans don’t require a down payment and closing costs are normally paid by the seller, many VA loan recipients end up putting that money toward closing costs and prepaid items or even getting it all back.

You can talk with a loan specialist at Veterans United, a VA lender, about any VA-loan related questions at 855-870-8845.