While you won’t be expected to dish out the full sale price when you buy a home, you will have to put up a certain amount of money to seal the deal, and an earnest money deposit is part of it. Basically, this deposit represents a promise to the sellers that you’re serious about buying and that you’ve got the financial means to make your mortgage payments in order to finalize the deal.
Let’s go over what an earnest deposit is and a few things you should know about it before you decide to make a home purchase.
1. They’re Not the Same as Down Payments
Many buyers may confuse earnest money deposits with down payments, but they’re not the same. While an earnest money deposit is the money that buyers offer sellers to prove that their intentions of buying the home are serious, a down payment is the amount of money that buyers need to come up with in order for the lender to approve the mortgage to finance the home.
Basically, an earnest money deposit is a commitment to the seller, while a down payment is a commitment to the lender.
2. The Amount of the Deposit is Usually a Percentage of the Sale Price (But Not Always)
Earnest money deposits are usually reflective of the sale price of the home. So, a more expensive home would usually require a higher deposit amount that a lower-priced property. The amount will also depend on the specific real estate market that you’re in, as every area has its own general practices surrounding deposits.
Further, a more competitive market would usually dictate higher deposit amounts. When buyers are competing with one another in a sizzling market – especially in bidding wars – the deposit amounts will usually be higher.
That said, the amount offered to sellers is usually based on a percentage of the purchase price, usually between 1% to 2%. In markets where homes are flying off the shelves, deposits can be even higher than this 1%-2% range, whereas slower markets may warrant amounts even less than 1% of the purchase price. However, sometimes a flat amount is offered, and not necessarily based on an exact calculation in reference to the sale price of the home.
3. The Money Will Be Held in Escrow
In the majority of cases, earnest money deposits are given to a third-party escrow company which holds the funds once the offer has been accepted and you sign the contract. In some cases, the listing real estate broker holds the deposit in a separate account. Under no circumstance should buyers ever give their deposit check directly to the seller, for obvious reasons.
Once the sale of the home is final, the funds held in the escrow account will be released from escrow and put towards the down payment.
4. Deposits Are Typically Refundable if the Deal Falls Through, But Not in All Cases
Earnest money deposits are refundable, but only if specific criteria are met. Buyers have the right to cancel a deal if they’ve included the appropriate contingencies in their offer and are unable to meet them. For instance, if a buyer’s offer is contingent upon them securing a mortgage but are denied financing, they can back out of the deal for this reason. Or, if a home inspection reveals issues that the buyer has a problem with (after including a home inspection contingency), the buyer can kill the deal based on unsatisfactory findings from the inspection.
But buyers can’t just arbitrarily back of real estate deals for no reason. Under certain circumstances, deposits may not be refunded back to the buyer. If it is found that the buyer did not meet all of the contractual obligations of the agreement, the buyer may be out of luck. In this case, the money will be handled according to the purchase agreement.
5. The Deposit Goes Towards the Purchase Price of the Home
Like other types of purchases that require a deposit, the amount handed over is credited towards the purchase price of the home. Whether you offer $5,000, $10,000, or even $100,000, the amount would go towards the price you agreed to pay for the home. So, the more you put down, the less your loan amount would subsequently be.
The Bottom Line
The earnest money deposit plays a key role in a real estate deal. The right amount can help sway a seller’s decision, especially in a hot market. But before you sign the check, it’s important that you know everything about these types of deposits in order to protect your hard-earned money.