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What is Earnest Money?

What is Earnest Money? | Down Payment vs Earnest Money | Realty Term

Earnest money is paid by a buyer to the seller of home as a sign of good faith that they plan to complete the deal and buy the home. Typically, earnest money is kept in an account until the deal closes – it also can be refunded without a set time period, after which it is not refundable.

Earnest money is different than a down payment. A down payment is made as part of the purchase of the home. It’s a set percentage of the overall cost that a buyer must come up with in cash. The money is usually kept in an escrow account and applied to a down payment once a deal goes through.

How Earnest Money Is Paid

Earnest money is really “good faith” money. It gives the seller assurance that a buyer plans to go through with a deal. In short, money talks. The amount is usually a percentage of the total sales price – typically 1% or 2%. So, at 1%, the payment would be $2,500 for a $250,000 home. In some cases, the amount is negotiable. Keep in mind that the more money a buyer offers, the more seriously a seller will take them.

When Earnest Money Is Refundable

Once a buyer pays the earnest money, it is kept in an escrow account overseen by the real estate brokerage, legal firm or title company. When the deal is completed, the money is used by the buyer as part of the down payment on a home (you want to pay 20% down to avoid costly mortgage insurance). The money may get refunded to the buyer under certain circumstances. The most frequent involve a home not being appraised at the sale price value or an inspection that discovers a previously unknown defect.

When Earnest Money Is Not Refundable

In other cases, buyers don’t get the money back. This can happen if they decide to withdraw from the deal for a reason that is not agreed upon in the contract. Also, a buyer can forfeit the money if they don’t meet deadlines as described in the contract. And, of course, a buyer will lose the money if they simply decide to walk away from the deal.

How It’s Applied to Down Payment

As well as a good faith gesture to the seller, putting up earnest money also can be seen as an installment on the down payment. As mentioned above, buyers typically want to accumulate about 20% of the total sales cost in cash for a down payment. However, many pay less – 20% is not mandatory. At the closing of the sale, the money is moved out of the escrow account and applied to the down payment, which is paid directly to the seller. An earnest payment may also go toward the buyer’s closing costs in some cases.

The main thing for buyers to keep in mind with earnest money is to pay close attention to the contract. Make sure it clearly spells out situations where the money will be refunded. Be very familiar with all the deadlines so none are missed.

If handled correctly, earnest money can better a buyer’s position with a seller. Just make sure to know all the details and keep your money protected.

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