Real Estate Contracts: What is Earnest Money?

Upon signing an offer to purchase a home, you will be asked to provide an earnest money deposit. This completely different than a down payment. Many people will become confused when their Realtor asks how much of an earnest money deposit they'd like to offer. Lets examine the importance of an earnest money check, where it goes and who it belongs to.

When you write an offer on a piece of real estate, it's important to accompany it with proof that you are serious about buying the home. The seller will oftentimes take the amount of earnest money provided into consideration when deciding on whether or not to accept your offer. The check will typically not be written directly to the sellers. Actually, it's a bad idea to do so. The money should be held in escrow and is typically written to the real estate company the buyer's agent works for. Sometimes, the seller will require it to be written to their agent's company. Either way, it is held in escrow not belonging to either party until the sale of the property is executed. The money then gets released to the lender and is credited to the buyers upon the sale of the home. In the event that the buyers decide not to go ahead and purchase the home, the money will be released to the sellers and the home will go back on the market. Basically, the earnest money deters the buyers from walking away from the purchase for no good reason. When the sellers accept a contract on their home, they are not legally allowed to accept another offer. This money acts as "insurance" for the sellers, making them feel comfortable about accepting the offer knowing the buyers are serious and will lose the money if they decide against going through with the sale.

Accepting an offer not accompanied by an earnest money check is somewhat foolish. The buyers can walk away with no penalty and the seller's home can be stuck in limbo for a period of time, not able to put it back on the market due to the original contract without earnest money. I have seen a house taken off active status for 60 days due to the sellers accepting an offer without an earnest money deposit. The buyers then decided they didn't want to buy the house after all and became impossible to contact. If this offer had an earnest money check attached to it, at least the sellers would have had some compensation for taking their home off active status for the 60 days.

There are several questions and concerns buyers have about earnest money. One involves problems getting the final approval on a mortgage. It's important to include in the contract a clause that states if the buyers can not get approved for a mortgage, the money will be refunded to them. A contract will typically allow the buyers 30-45 days to get their finances in order. A buyer should be pre-approved for a mortgage before writing an offer. However, it's important to understand that this is not an official approval. There are several snags that could happen along the way to prevent the buyers from getting that final approval. So, if the contract is written correctly, the buyers should have no problems getting this money back if they are declined.

Another way to get earnest money back is through a bad home inspection. There should be a clause in the contract stating that if the inspection comes back with any major problems, the earnest money will be refunded to the buyer. The contract will typically state the buyers have 20-30 days to have an inspection done. It's important to have this done within the timeframe stated in the contract.

There are several other clauses that could be included in the contract allowing the buyers to get back their earnest money. So, whatever is a concern for the buyers should be included in the contract for the seller's consideration. It could be that the buyer is out of state and wanting to write a contract on a home, but also wants to actually see the property before closing. In this case, the contract will state a specific time frame in which the buyer will have to view and approve the property.

Remember when you are negotiating the sale of a property, you are not just negotiating price. You are also negotiating terms. The amount of an earnest money check is one of those terms that is highly considered along with the situations in which the buyers will get the earnest money back.

As mentioned earlier, it is not a good idea to have the sellers hold the earnest money check. Have it held in escrow by either a real estate company or a real estate attorney who will release it to whoever it legally belongs to.

It's always a good idea to write an offer including a considerable amount of earnest money. A good earnest money check will be about 1-3% of the purchase price. When placing or considering an offer to purchase real estate, think about how easy it would be to walk away from the earnest money. It may be easy for the buyers to lose a $500 deposit, but not so easy to walk away from $5,000