By Steve Gillman - 2005
Earnest money is a deposit included with an offer-to-purchase,
to show the seller that the buyer is serious about purchasing
the house. It becomes part of the down payment if the offer is
accepted, is returned if the offer is rejected, or is forfeited
if the buyer pulls out of the deal for reasons other than those
stipulated in the offer. A financing contingency is an example
of the latter - if the buyer's offer was contingent on getting
a loan, and he couldn't, he can cancel the contract and get his
earnest money back.
How Much Earnest Money?
The amount of the earnest money deposit is ultimately up to
you. Some real estate agents will outright tell you it is this
or that amount, or this or that percentage of the offering price.
The truth is that you can write the offer with a one dollar deposit
if you wish, and agent still has to present the offer.
Of course, an offer with one dollar of earnest money may not
be taken seriously, and the agent may even persuade the seller
that you are not a serious buyer. The right amount then, is probably
whatever the local norm is. We just bought a home in Colorado,
and the agent told us that a $1,000 deposit was normal. Had he
said $5,000 was normal, however, I still would have given a deposit
of just $1,000. That is enough to be serious in my mind.
Another way to approach this is to do a two-part deposit.
You might make an offer with just $100 in earnest money, for
example, but specify in the offer that this will be increased
to $2,000 once the offer is accepted, or once when an inspection,
appraisal or other contingency is met. This keeps your money
from being tied up until you know that the seller is serious
about selling to you.
Who Holds the Earnest Money?
Don't ever give your earnest money check to the seller. If
the real estate office that is handling the sale has an escrow
account, it should be safe to make the check out to the broker.
Otherwise, use a title company or other escrow account. The last
thing you need is a seller keeping your money after you pull
out of a deal because of financing problems, termite infestations
or other valid contingencies in your offer. Always give your
deposit to a third party to hold.
Ask how they hold it and return it too. I once had an offer
rejected, and then had to wait a week to get my money back. They
told me that they had to wait for my check to clear before they
could issue a check back to me. I prefer it when it is handled
like it was on our recent home purchase. They just hold the check
until the offer is accepted, and return or destroy it if the
offer is rejected.
Things happen. If you have to pull out of the deal for some
unforeseen reason - one not included in the contract - you will
lose your deposit. The seller could also sue you for additional
damages or force you to buy the home. To avoid this, have a clause
in the offer that specifies that the earnest money will be "liquidated
damages" if you are in default. Ask for help with the language,
but this basically means that if you need to default on the contract,
the seller cannot ask for more than what you have already included
as earnest money.
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