Real Estate Term: Earnest Money
When a buyer and seller reach agreement on a home sale, the buyer typically puts a small amount of money into a trust account.
This up-front deposit is more commonly known as 'earnest money'.
A sales contract's earnest money requirement will vary from contract to contract. It can be as high as 10 percent of the purchase price and could be as low as $500; earnest money is a negotiable item between buyers and sellers.
Some factors that can influence earnest money amounts include:
- Market conditions: Stronger markets often call for more earnest money
- Buyer economics: First-time buyers often give less earnest money
- Seller psychology: Skeptical sellers often ask for more earnest money
No matter how large or how small, however, earnest money is supposed to give the seller a sign of good faith that the buyer wants to purchase the home.
To this end, earnest money can be forfeited if the buyer later 'backs out' of the deal, or breaches the terms of the purchase agreement. Breaching, however, is infrequent.
This is because most purchase contracts are written with buyer-focused 'outs' called 'contingencies'.
A typical contingency is that the seller must provide a clean title policy to the buyer, or that the buyer must secure financing prior to given date, or that the home must pass a satisfactory inspection.
If any of these contingencies cannot be met, the purchase agreement is voided and earnest money returned to the buyer. When contingencies are met, however, earnest money becomes a deposit and is applied directly to the buyer's bottom line at settlement. If the buyer is expected to have $50,0000 for the closing, for example, the true bottom line is $50,000 minus the earnest money deposit.
Earnest money customs vary from state to state, city to city, and even locale to locale. Be sure to ask your real estate agent and/or real estate attorney for professional counsel before signing purchase contracts.
The earnest money you save may be your own.