The Guide To Earnest Money
In a fast-moving housing market where you compete with homebuyers who make an offer within hours of a house going on the market, you'll do anything you can to make your bid more competitive. You can write a personal letter to the seller, promise a short time period until closing or include an escalation clause for the price.
Another part of your offer that could help it stand out compared to other buyers is your offer of earnest money. Done right, it can make yours the winning bid. But done wrong, it can have no impact, or even put too much financial pressure on you. Here's what you should know about earnest money in a real estate offer.
What Is Earnest Money?
Earnest money is a deposit from the buyer to seller, made in good faith to show dedication to purchasing the property. The amount of earnest money put forward is determined by the buyer and included in the offer to the seller.
The inclusion of earnest money is meant to help make the offer look sincere and enticing. "I want to buy your house so much that I'm going to give you X amount of money," says Molly Gallagher, real estate agent and partner of the Falk Ruvin Gallagher Team, part of real estate brokerage Keller Williams Milwaukee North Shore.
Earnest money is placed into an escrow deposit and managed by the listing agent, title company or an attorney involved in the deal. The money you've placed in escrow as earnest money goes toward the total amount of cash you pay at closing, including your down payment for a mortgage and closing costs.
How Much Earnest Money Should You Offer?
Earnest money should be an amount of money you are able to provide within three days of your offer being accepted. Ideally, it's enough to make the seller feel you're serious about buying the home.
"It all depends on the market conditions, however, typically 3% of the purchase price is a rule of thumb," wrote Chris Stuart, CEO of real estate brokerage franchise network Berkshire Hathaway HomeServices, in an email. "Alternatively, buyers may choose to use a rounded amount ($5,000 or $7,000) in markets where you see the majority of homes selling to first time buyers or where mortgages tend to be FHA or VA (where the buyer has limited funds to use earnest money), or where the average sales prices are lower than other areas."
Gallagher explains that in Milwaukee, earnest money deposits used to be much higher, around 10% to 20% of the purchase price. But as home prices have climbed and the size of mortgages have increased, the earnest money homebuyers are able to include has shrunk. Between 3% and 5% of the purchase price is the preferred earnest money amount today, she says.
"People are borrowing so much money to buy a house they don't really have a chunk of cash to put down up front," Gallagher says.
In the luxury housing market of South Florida, however, a larger good-faith deposit is necessary. "If you want your offer to be considered seriously, you need to put down 10% of the purchase price," says Elena Bluntzer, a real estate agent for ONE Sotheby's International Realty in Coral Gables, Florida.
You may find it beneficial to provide your earnest money in two different escrow deposits. Dennis Bowers, a real estate agent with Compass in Naples, Florida, says a buyer could provide a smaller deposit within the initial three-day window, maybe around $5,000 for a $500,000 home. "The second earnest deposit is typically done after your due diligence period or any contingent period you have," Bowers says. This second deposit would be larger, bringing the total earnest money closer to something like 10% of the purchase price.
California law, on the other hand, limits the amount of earnest money that can go to a seller should the deal fall through to 3% of the purchase price. There are some exceptions, Stuart says, but this law makes it so few earnest money deposits exceed 3% in the Golden State.
Do You Have to Include Earnest Money in Your Offer?
Earnest money may not be legally required, but it's a standard enough practice in most parts of the U.S. that you can expect your real estate agent and a real estate attorney to require an earnest money deposit in your offer.
"It's not required; however, the absence of an earnest money deposit would indicate a lack of interest and motivation on the parts of the buyers," Stuart says. "Regardless of the market – buyer's or seller's market – you should always have an earnest money deposit."
Either way, it's an important part of showing the seller that you're serious. Much of the U.S. is facing a seller's housing market, meaning the number of buyers outnumber homes on the market. Properties sell fast and multiple offers are common. "It shows that you're real (and) you're not going to walk away," Bowers says.
Can Earnest Money Make Your Bid Win?
Earnest money can certainly be a key part of a winning offer. But without a competitive offer price, and other enticing details such as an all-cash purchase, waived contingencies and ideal timeline, a high amount of earnest money on its own is unlikely to get your offer accepted when competing with other offers.
"Earnest money is not going to make or break a deal in that they're going to accept your offer just because you have higher earnest money," Bowers says.
Bluntzer says that when she represents a seller and a buyer's offer comes in with a low amount of earnest money, the counteroffer she and the seller craft includes raising the good-faith deposit to 10%.
What Happens to Earnest Money if the Deal Falls Through?
The point of earnest money is to give the seller some financial compensation if the buyer backs out. There are, however, a couple scenarios where the buyer gets the earnest money back: If the lender denies the mortgage loan at the purchase price, and if the inspection reveals issues that changes the buyer's mind.
Following revelations in an inspection, "the buyer must cancel the contract in writing within the inspection period or at least the very last day of the inspection period in order to get their money back," Bluntzer says.
Some buyers may try to cover up their cold feet by finding issue with something in the inspection, but Gallagher says it's pretty obvious to agents on both sides of the deal when it's not a sincere inspection-related problem. If you want to back out of the deal, it's OK, but the earnest money should go to the seller – that's what the earnest money deposit is for.
"They've now taken their house off the market for two weeks while you screw around with your inspection," Gallagher says.
Still, the earnest money won't go to the seller by default in any situation. "It's important to note that the earnest money isn't just automatically awarded, as both agents must sign off before that deposit goes to the seller," Stuart says. "Frequently it's a mediated process to determine what (or) if any portion of the deposit goes to the seller based on the actual circumstances. On the other side, if the transaction is canceled prior to all contingencies being removed, the money should automatically be returned to the buyer."