An Earnest Look At Earnest Money

Dated: 02/06/2016

Views: 311

I often hear misunderstandings of what earnest money is and what it means to a contract in Washington State.  It is a very important factor in the home buying process and should be understood by both parties.

An easy definition of it is a good faith deposit in the form of liquidated damages if you illegally break your purchase agreement.

So what does that mean? 

A buyer finds a home they like and make an offer to purchase it.  The earnest money is deposited by the buyer into a holding account called an escrow.  The seller agrees to the purchase and takes their home off the market and the earnest money waits in the escrow account until closing.  This gives the buyer time to do their due diligence, have a home inspection, get an appraisal, finish up their financing approval, and complete mortgage documents without worrying that the seller will take another offer.  At closing, the earnest money is applied to the buyer's closing costs or down payment.  It can even sometimes be returned to the buyer if these other costs are fully covered.  The earnest money still belongs to the buyer upon successful completion of the purchase and sale contract terms.

If the contract is broken and the buyer is in default, they risk losing the earnest money. The seller may have already put a deposit down on another home or missed out on another buyer that would have completed the purchase.  The earnest money is given to the seller as damages.  Your real estate broker can write in several different contingencies to protect your earnest money such as, inspection, appraisal, financing, insurance, title and more.  Please notice that "I changed my mind." is not a contingency.  If you are outside any of these protection limits, you may forfeit your earnest money.  If you are within the protection of your contingencies, you may be entitled to have the earnest money returned to you. 

How much money should earnest money be?

Many first time home buyers can only afford to put down $500 and a contract does not have to have any earnest money at all to be valid.  Earnest money does show the seller that you are serious.  The larger the amount of earnest money, the more of a financial interest a buyer has in completing the transaction.  This market is hot and it is not uncommon to see multiple offers.  If two offers are presented to a seller with exact terms but different earnest money, which one do you think the seller would choose?  Most likely it would be the one with more earnest money.  Buyer's can usually put down any amount they want.  However, bank owned homes often call for a certain amount and as much as 10% from investors in earnest money.

How is earnest money deposited?

There will be specific terms laid out in your agreement or how and when the deposit is to be made.  It may be a personal check, money order, cashier's check, or a wire directly sent to the escrow holder.  As mentioned, it may not even be monetary funds at all.  It could be a title to a car, a wedding ring, or even just a promissory note.  It is very important that the terms and conditions are met exactly as agreed upon or else a breach in contract has already occurred.  Even though there is no minimum amount, remember that the purpose of earnest money is to compensate the seller if the buyer defaults.

Can earnest money be non-refundable?

NO!  I hear this a lot and it is a misconception of the definition of earnest money and the role it plays.  By law, earnest money must be refundable just like a security deposit is for a tenant.  Sometimes you may be required to put down money that will be forfeited if the contract is not completed.  We often see this in new construction and it should be treated as a non-refundable deposit, not earnest money.  The buyer can put down both or usually just one.

On a closing note, it is very important that you are familiar with the terms of your contract as a buyer and as a seller.  When a deal falls apart, the seller does not automatically get the earnest money, nor does the buyer automatically get it back. Go back and re-read the terms.  Remember that your purchase agreement is a binding contract and should clearly state what is expected and what happens if those expectations are not met.  If both buyer and seller still have a dispute as to what should be done with the earnest money, they will most like be advised to seek legal counsel.  This cost can far exceed the amount of earnest money in question for both parties.

If you have any questions, ASK! Make sure you are comfortable with the details and can hold up your end of the bargain. Happy House Hunting! ~ Jennifer Shupe, RE/MAX Infinity Group

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