Are you confused by all the real estate jargon out there?
Today, I’m answering the question: “What is earnest money?”
#1: What is an Earnest Money Deposit?
An Earnest Money Deposit (EMD) is a good-faith deposit to show the sellers that you’re serious about purchasing their property and asking them to take it off the market and put it under contract for you to purchase. So, one way of thinking about it, is kind of like a marriage proposal. You typically only propose to one person at a time, and you don’t propose to others at the same time. And it’s to show your commitment to see it through. And so, in a proposal, your commitment is hopefully marriage someday, and with a house, your commitment is to close in escrow.
An Earnest Money Deposit isn’t any additional money or costs. It’s just part of your either closing costs or down payment.
#2: How much should the Earnest Money Deposit be?
Typically, we see EMDs between 1% and 3% of the purchase price. Sometimes, if you want to minimize the risk of a buyer, you can go with about 1%. If it’s a really hot property, and you feel that that might make a difference in getting your offer accepted by offering 3% — a lot of times that’s what people will do: they’ll offer 3% of the purchase price, and then maybe round it up to the nearest thousand. So if it’s a $300,000 house, you can do $9,000 EMD. Or just round it off to $10,000. Occasionally, let’s say someone doesn’t have that much money upfront, or they’re borrowing the money, or there’s all kinds of different ways as far as how down payment as far as where it comes from — a lot of times the sellers would accept a offer with a much less than 1% EMD. So occasionally we see them, you know, they’re $1,000 or $2,000 or $2,500 — and a lot of times you see that from first-time home-buyers. It’s not that the property for the deposit is at risk, it’s just one of those things that, you know, it’ll look better the bigger it is.
#3: When do we make the Earnest Money Deposit? To who and who’s going to hold onto it?
So here in the state of California, if you look at the standard way that our Purchase Agreement/offer paperwork is written, it says that it’s going to be wire-transferred to an escrow company within the first three days. That’s a good way of going about it. But I’ve realized that a lot of times if it says wire-transfer, and you take down a check, the escrow company will most likely take a check because they’re getting the money. So basically, an escrow company is the one who is going to be holding it the whole time, and kind of like in charge of it to protect it for you. On occasion, people will get the house under contract; that they’re wanting to buy, but they’re having a challenge sending in or somehow getting the EMD. So if you don’t do it within the time specified (usually three days), that you could be in breach of contract. Of course, that can cause a little more stress on the sellers’ part and actually void your contract. The sellers at that point, if you don’t turn in the EMD, could start the process of cancelling your escrow and your contract.
#4: How can we get the Earnest Money Deposit back or how is it used?
So, let’s say that everything goes perfectly to escrow, and you’re ready to close on your property. Well, that Earnest Money Deposit is going to go toward your down payment and your closing costs. And so that way, it’s not any initial money out of pocket. Let’s say you’re using a VA loan, it’s possible that you can get some of that money back at the close of escrow. Typically, it goes with the down payment and closing costs. Let’s say, for some reason you did your home inspections or you couldn’t come to an agreement on repairs and things, and you decided that you have to cancel the escrow or the contract. Well, if you do it within your contingency period, then you basically just fill out the forms and request escrow to give you your deposit back. In the future I’ll do another video on those so you can get a good idea.
Some of the main contingency periods are: the inspection contingency, appraisal contingency, and loan contingency.
With the inspection contingency, you go in with the home inspector, make sure everything is what you want it to be, or negotiate the repairs with the sellers. If you come to an agreement, then you’re good. If not, then that’s your opportunity to walk away.
Then you typically have an appraisal contingencies. So it’s a contingency that the property is going to appraise for the value of the contract. If not, you can renegotiate it or cancel and you get your money back.
There’s also the lender contingency or loan contingency. That one doesn’t happen too too often. But let’s say something along the process something happens, and the lender cannot give you a loan. Hopefully not at the last moment, but towards the end, you’re able to cancel, saying you cannot get a loan.
And so, those are a few different ways of getting your deposit back with contingencies. We’ll do another video on contingencies so you have a good idea of different things to look out for, and one on timelines.
#5: How to protect your Earnest Money Deposit
So when you get your offer accepted, it’s time to wire funds to escrow. And what you want to do, is to double-check those wire instructions and routing numbers. So, usually it’s a good idea to call the escrow company and verify it over the phone with somebody from that escrow company, instead of an email. Because wire fraud is on the rise, and we don’t want you to wire your funds overseas to somebody else and it’s gone.
Another thing to protect your EMD is to stay on top of the contingency periods. You’ve got to know your timelines and what needs to happen during those time periods. Contingencies are automatically gone, they’re actually signed off, so it’s a good thing to an eye on those. So keep up on your responsibilities that you have to do during the period of escrow, such as: doing your home inspection, your due diligence, and more that your real estate agent will keep you informed on. And anytime that you’re concerned with things, or you’re not sure, you want to make sure you get it in writing. For example, let’s say the contingency period comes up where it’s time to sign off but we’re not ready yet, then we’d sign in writing to get an extension.
Those are the main things to know about Earnest Money Deposits. If you have more questions, please comment below or contact me!
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