Earnest Money - Real Estate Investing

Earnest money is a deposit made to a seller that represents a buyer's good faith to buy a home. The money gives the buyer extra time to get financing and ... AlternativeInvestments RealEstateInvesting RealEstateInvesting RealEstateInvestingGuide TableofContents Expand WhatIsEarnestMoney? UnderstandingEarnestMoney SpecialConsideration:ProtectingYourEarnestMoneyDeposit ExampleofEarnestMoney WhatIsEarnestMoneyUsedFor? DoesEarnestMoneyGetReturned? HowCanEarnestMoneyBeProtected? WhatIsEarnestMoney? Earnestmoneyisadepositmadetoasellerthatrepresentsabuyer'sgoodfaithtobuyahome.Themoneygivesthebuyerextratimetogetfinancingandconductthetitlesearch,propertyappraisal,andinspectionsbeforeclosing.Inmanyways,earnestmoneycanbeconsideredadepositonahome,anescrowdeposit,orgoodfaithmoney. KeyTakeaways Earnestmoneyisessentiallyadepositabuyermakesonahometheywanttopurchase.Acontractiswrittenupduringtheexchangeoftheearnestmoneythatoutlinestheconditionsforrefundingtheamount.Earnestmoneydepositscanbeanywherefrom1–10%ofthesalesprice,dependingmostlyonmarketinterest. 1:12 EarnestMoney UnderstandingEarnestMoney Inmostcases,earnestmoneyisdeliveredwhenthesalescontractorpurchaseagreementissigned,butitcanalsobeattachedtotheoffer.Oncedeposited,thefundsaretypicallyheldinanescrowaccountuntilclosing,atwhichtimethedepositisappliedtothebuyer'sdownpaymentandclosingcosts. Whenabuyerdecidestopurchaseahomefromaseller,bothpartiesenterintoacontract.Thecontractdoesn'tobligatethebuyertopurchasethehome,because reportsfromthe homeappraisal andinspectionmaylaterrevealproblemswiththehouse.Thecontractdoes,however, ensurethesellertakesthehouseoffthemarketwhileit'sinspectedandappraised.Toprovethebuyer'soffertopurchasethepropertyismadeingoodfaith,thebuyermakesanearnestmoneydeposit(EMD). Thebuyermightbeabletoreclaimtheearnestmoneydepositifsomethingthatwasspecifiedaheadoftimeinthecontractgoeswrong.Forinstance,theearnestmoneywouldbereturnedifthehousedoesn'tappraiseforthesalespriceortheinspectionrevealsaseriousdefect—providedthesecontingenciesarelistedinthecontract. However,earnestmoneyisn'talwaysrefundable.Forexample,thesellergetstokeeptheearnestmoneyifthebuyerdecidesnottogothroughwiththehomepurchasefor contingencies notlistedinthecontractorifthebuyerfailstomeetthetimelineoutlinedinthecontract.Thebuyerforfeitstheearnestmoneydepositiftheysimplyhaveachangeofheartanddecidenottobuy.  Earnestmoneyisalwaysreturnedtothebuyerifthesellerterminatesthedeal. Whilethebuyerandsellercannegotiatetheearnestmoneydeposit,itoftenrangesbetween1%and2%ofthehome'spurchaseprice,dependingonthemarket.Inhothousingmarkets,theearnestmoneydepositmightrangebetween5%and10%ofaproperty'ssaleprice. Whiletheearnestmoneydepositisoftenapercentageofthesalesprice,somesellerspreferafixedamount,suchas$5,000or$10,000.Ofcourse,thehighertheearnestmoneyamount,themoreseriousthesellerislikelytoconsiderthebuyer.Therefore,abuyershouldofferahighenoughearnestdeposittobeaccepted,butnotonesohighastoputextramoneyatrisk. Earnestmoneyisusuallypaidbycertifiedcheck,personalcheck, orawiretransferintoatrustorescrowaccountthat isheldbyarealestatebrokerage,legalfirm, ortitlecompany.Thefundsareheldintheaccountuntilclosing,whentheyareappliedtoward thebuyer'sdownpaymentandclosingcosts.It'simportanttonotethatescrowaccounts,likeanyotherbankaccount,canearninterest.Iftheearnestfundsintheescrowaccountearninterestofmorethan$600,thebuyermustfillouttax formW-9 withtheIRStoreceivetheinterest. Thoseinterestedinlearningmoreaboutearnestmoneymaywanttoconsiderenrollinginoneofthebestonlinerealestateschools. Prospectivebuyersforfeittheirearnestmoneyiftheydecidetobackoutofapurchase. SpecialConsideration:ProtectingYourEarnestMoneyDeposit Prospectivebuyerscandoseveralthingstoprotecttheirearnestmoneydeposits. Makesurecontingenciesforfinancingandinspectionsareincludedinthecontract.Withoutthese,thedepositcouldbeforfeitedifthebuyercan'tgetfinancingoraseriousdefectisfoundduringtheinspection.Read,understand,andabidebythetermsofthecontract.Forexample,ifthecontractstatesthehomeinspectionmustbecompletedbyacertaindate,thebuyermustmeetthatdeadlineorrisklosingthedeposit—andthehouse.Makesurethedepositishandledappropriately.Thedepositshouldbepayabletoareputablethirdparty,suchasawell-knownrealestatebrokerage,escrowcompany,titlecompany,orlegalfirm(nevergivethedepositdirectlytotheseller).Buyersshouldverifythefundswillbeheldinanescrowaccountandalwaysobtainareceipt.  ExampleofEarnestMoney SupposeTomwantstobuyahomeworth$100,000fromJoy.Tofacilitatethetransaction,thebrokerarrangestodeposit$10,000asadepositinanescrowaccount.ThetermsofthesubsequentagreementsignedbybothpartiesstatethatJoy,whoiscurrentlylivinginthehome,willmoveoutofitwithinthenextsixmonths. Butsheisunabletofindanotherplaceofresidencebymovingday.Asaresult,Tomcancelsthetransactionandgetshisdepositmoneyback.Thedepositmoneyhasearnedinterestof$500fromtheescrowaccountduringthistimeperiod.Sincetheamountislessthan$600,TomisnotrequiredtofilloutanIRSformtoretrievetheamount. WhatIsEarnestMoneyUsedFor? Inrealestate,earnestmoneyiseffectivelyadeposittobuyahome.Usually,itrangesbetween1-10%ofthehome’ssaleprice.Whileearnestmoneydoesn’tobligateabuyertopurchaseahome,itdoesrequirethesellertotakethepropertyoffofthemarketduringtheappraisalprocess.Earnestmoneyisdepositedtorepresentgoodfaithinpurchasingthehome. DoesEarnestMoneyGetReturned? Earnestmoneygetsreturnedifsomethinggoesawryduringtheappraisalthatwaspredeterminedinthecontract.Thiscouldincludeanappraisalpricethatislowerthanthesaleprice,orifthereisasignificantflawwiththehouse.Importantly,though,earnestmoneymaynotbereturnediftheflawwasnotpredeterminedinthecontractorifthebuyerdecidesnottopurchasethehouseduringanagreedupontimeperiod.  HowCanEarnestMoneyBeProtected? Toprotectanearnestmoneydeposit,prospectivebuyerscanfollowanumberofprecautionarysteps.First,buyerscanensurethatcontingenciesapplytodefects,financing,andinspections.Thisprotectsthedepositfrombeingforfeitedinthecasethatamajorflawisdiscovered,orthatfinancingisnotsecured.Second,carefullyreadandfollowthetermsofthecontract.Insomecases,thecontractwillindicateacertaindatebywhichtheinspectionmustbemade.Topreventforfeiture,thebuyershouldabidebythesetermsaccordingly.Finally,ensurethedepositishandledadequately,whichmeansthatthebuyershouldworkwithareputablebroker,titlefirm,escrowcompany,orlegalfirm.  ArticleSources Investopediarequireswriterstouseprimarysourcestosupporttheirwork.Theseincludewhitepapers,governmentdata,originalreporting,andinterviewswithindustryexperts.Wealsoreferenceoriginalresearchfromotherreputablepublisherswhereappropriate.Youcanlearnmoreaboutthestandardswefollowinproducingaccurate,unbiasedcontentinour editorialpolicy. InternalRevenueService."InstructionsfortheRequesterofFormW-9."AccessedSept.13,2021. RelatedTerms ContingentPaymentSale Acontingentpaymentsaleisatypeofsalewherespecificsofthesale,suchasfullsalesprice,dependuponfutureevents. more GoodFaithMoney Goodfaithmoneyisa depositofmoneyintoanaccountbyabuyertoshowthattheyhavetheintentionofcompletingadeal. more WhatIsanAccountinTrust? Anaccountintrustisatypeoffinancialaccountopenedbyonepersonforthebenefitofanother. more LoanEstimate Aloanestimateisathree-pageformthatpresentshomeloaninformationinaneasy-to-read,well-explainedformat,makingiteasytocompareoffers. more RetractDefinition Aretractisthewithdrawalofabid,offer,orstatementbeforeanyrelevantpartyactsontheinformationprovided. more HowEscrowProtectsPartiesinFinancialTransactions Escrowbroadlyreferstoathirdpartythatholdsmoneyoranassetonbehalfoftheothertwopartiesinatransaction. more PartnerLinks RelatedArticles PurchasingAHome Whenshouldarealestatebrokerreleaseearnestmoneydepositfunds? 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