Earnest money shows a seller that a buyer is in earnest about purchasing their home. Earnest money is a negotiable dollar amount that the buyer delivers once they have reached mutual acceptance to purchase the home.
Here are the frequently asked questions I get from my clients about earnest money, what it is for and how it works.
Note: The following is based on the Northwest Multiple Listing Service forms I use here in my market of Thurston County, WA and the greater South Puget Sound area. Real estate forms and practices are local. Please keep in mind your situation and contract may be different. As always, please consult with your broker and your real estate attorney for advice regarding your earnest money and your purchase and sale agreement.
What is the purpose of earnest money?
Earnest money can be a negotiation tool for a buyer.
A buyer who offers a large earnest money deposit can show the seller their financial strength and their seriousness about buying their home. Earnest money is collected and deposited within days of mutual acceptance. This means the buyer would need to have those funds ready and available to deposit. In other words, the check needs to clear. Because earnest money funds are liquid and available, a seller would feel a buyer offering $10,000 in earnest money is financially stronger than a buyer offering $500.
Earnest money, in most cases, is the remedy to a seller if the buyer breaches the agreement.
Our contracts give buyers and sellers a choice how they want to handle a breach of contract, and this is negotiated at the time of the offering being submitted. They can choose to forfeit the earnest money to the seller or they can choose other remedies determined by the seller. Most of my buyers will choose to forfeit their earnest money to the seller because that is a known, set dollar amount.
Is earnest money required?
Technically no, because it is a negotiable item between a buyer and a seller. However, a buyer would be hard-pressed to find a seller who would accept those terms. Earnest money is usually the remedy to the seller if the buyer defaults, therefore a seller would want to see an earnest money deposit.
How much earnest money should I put down?
Earnest money is negotiable, and buyers are influenced with how much to put down by several factors.
- What are the local customs? Your broker will certainly guide you on this. In some markets, sellers and their listing brokers expect buyers to put down at least five percent of the purchase price in earnest money. In other markets, one-half percent of the purchase price is more than acceptable.
- Is it a buyer’s market or a seller’s market? In working in both buyer and seller markets, I have seen the wide range of earnest money deposits. In a buyer’s market, sellers were accepting $500 in earnest money on a $300,000 home purchase. In a seller’s market and a market where buyers may be competing for the same property, that same $500 will not get you far. This is where I would recommend to my buyer-clients that they may want to put down 1-3% of the purchase price in earnest money.
Buyers want to put the least amount of earnest money down to lessen their risk of losing their earnest money while sellers want the most amount of earnest money to secure that buyer in completing the transaction and to cover their damages in case the buyer defaults.
What damages would a seller suffer if a buyer doesn’t go through with the purchase?
Once a seller agrees to a buyer’s offer, the seller takes their home off the market and waits for the buyer to complete their contingencies and successfully close on the home. If the buyer breaches the contract and fails to purchase the home, this typically happens just before the close date. The seller has had the home off the market for several weeks only to find out the buyer will not complete the transaction. The damages to the seller can be great. Here are a few examples:
- The seller may have extra, unplanned mortgage payments.
- The seller is under contract to purchase another home with the funds from this sale. They might have had to cancel their purchase.
- The seller may have already moved out and into another home, and now they have two mortgage payments.
- The timing of when the home comes back on the market could be detrimental to the seller based on current market conditions.
As a buyer, you can understand that $1,000 or $2,000 really wouldn’t cover the damages to a seller. Sellers also need to carefully consider what it would cost them if a buyer didn’t go through with the sale when reviewing offers.
When and how is earnest money collected?
In our purchase and sale agreement, the boilerplate language says the buyer will deliver the earnest money to the escrow company within two business days of mutual acceptance. (Your contract may have different timelines – please check with your broker.) If buyer and seller agree to all the terms of the purchase and sale agreement on a Monday, then by Wednesday, the buyer needs to deliver their earnest money to the designated escrow company. Once delivered, the earnest money funds are deposited into the escrow account where the funds are held until closing or until termination.
The two most preferable ways buyers can deliver their earnest money to the escrow company is by wiring the funds or by delivering a personal check. The escrow company will provide the buyer with instructions and options.
Can I use a credit card for my earnest money?
No. The earnest money funds need to be liquid cash funds. These are funds that are in your checking or savings account. These are funds that are readily available for the escrow company to deposit.
Can my parents pay for my earnest money deposit?
Unless your parents are on the purchase and sale agreement, typically this answer is no. The earnest money funds need to come from the buyers. If the buyer is relying on gift funds for the earnest money or any other funds in the buyer’s loan process, the buyer should immediately contact their lender for guidance.
What if my earnest money check bounces?
If the earnest money check bounces and funds are not available, the escrow company is required to notify all parties. The seller then has the option to terminate the agreement.
What if I don’t deliver my earnest money check by the due date?
If the buyer misses the deadline to deposit the earnest money, an addendum can be drafted stating that the parties agree to extend the due date for the earnest money. But the buyer is putting themselves in jeopardy as the seller does not need to agree to this and can terminate the transaction.
What happens to the earnest money upon a successful sale?
If the transaction closes successfully, then the earnest money is credited to the buyer. The earnest money would be applied to the buyer’s closing costs, and anything left would be returned to the buyer at closing. Earnest money is not applied to the purchase price nor the down payment however confirm with your lender how any earnest money credits could be applied.
How could a buyer lose their earnest money to the seller?
A buyer could be in breach and lose their earnest money to the seller by terminating the contract outside of the contract terms.
An example would be if a buyer misses a deadline for a contingency.
If a buyer has 10 days to respond to a seller per a home inspection contingency, and the buyer responds on day 11 that they want to terminate, the buyer would lose their earnest money if they terminated. Because they missed the deadline to terminate, the buyer would either terminate and forfeit their earnest money or could choose to continue with the transaction. Regardless, their home inspection contingency is over – it has been waived by the end of day 10.
How can a buyer protect their earnest money?
For buyers, the goal is to protect the earnest money. This means making sure the buyer meets their deadlines. This is where having an experienced buyer-broker is imperative. You want your broker to be organized and give you a calendar outlining the contingencies and their due dates.
For some buyers, they get cold feet and want to terminate. This is a big decision and working closely with your buyer-broker is key. Many times, buyers don’t know all the facts and the unknown is terrifying. Make sure you have a broker who will explain the process, set expectations, and discuss different options and possible scenarios so that you are better prepared for any challenges that come up in your transaction.
What happens if I have a dispute with who gets the earnest money?
Buyer and seller sign a contract and for the most part, the contract is clear about who would get the earnest money. However, in this situation, emotions may get the best of the parties, and one side may not agree to release the earnest money to the other.
The language in the contract itself is not enough to release the earnest money to a party. Because the escrow company, a third party, is holding the earnest money, the escrow company needs written instruction for who gets the earnest money. Buyer and seller will need to agree and sign an Authorization to Disburse Earnest Money form outlining who gets the earnest money.
This is where the parties may not readily sign.
Other disputes may not be clear in the contract, and both parties may have valid reasons to keep the earnest money. In this case, it would be wise to contact a real estate attorney for guidance.
But regardless, if the parties cannot agree who gets the earnest money, the case is turned over to the Washington State Superior Court and through a trial, the court will determine who is entitled to the earnest money.
Is earnest money the same as a down payment?
No. Your down payment is separate from your earnest money. Upon a successful close, your earnest money would be credited back to you and applied to any outstanding loan costs – not to your down payment or purchase price. However, confirm with your lender how any earnest money credit can be applied.
What is non-refundable earnest money?
The term non-refundable earnest money commonly comes up with buyers purchasing brand new construction. Simply put, this means that no matter the reason, if the buyer fails to close and purchase the home, the seller keeps the earnest money. In other words, the buyer has no contingencies in place. If a buyer has no contingencies, then a buyer has no legal reason for failing to purchase the home and therefore, no right to recover the earnest money.
But…..if the earnest money is non-refundable that doesn’t mean the buyer has automatically forfeited that earnest money to the seller. Upon a successful sale, the earnest money will still be credited to the buyer at closing.
The risk for the buyer in entering a contract where the earnest money is non-refundable is the buyer will not have any “outs” (contingencies) to not purchase the property without losing their earnest money.
Is there a different earnest money requirement for VA borrowers?
No. Earnest money is negotiable and it doesn’t matter if the buyer is paying cash or obtaining any type of loan whether that be a VA loan, Conventional, FHA, etc.
Conclusion
Earnest money is a lengthy conversation as you can see, and I work with my buyer and seller clients so that they have a solid understanding of what earnest money means to them for their transaction. For more about the home-buying or home-selling process, be sure to check out my guides for success.
If you are looking for a broker to help you with your real estate needs, whether you are buying or selling a property, contact me today!