November 12, 2021
When you’ve found a home, you’d like to purchase, and you’re ready to make an offer, putting down an earnest money deposit (also called good faith deposit or earnest funds) lets everyone know you’re prepared to do business. It tells the seller you’re serious about their property and signals the start of the purchase process.
A good faith deposit usually goes into a trust or escrow account held jointly by the seller and the buyer. Sound like a commitment? It is — but there are protections in place. The earnest funds are controlled by a neutral third party like a title company and include limitations that protect both you and the seller.
#1 The earnest money for a home purchase is not an additional cost.
As you prepare to buy a home, you'll want to be saving up a down payment. Think of your good faith deposit as part of your down payment and an advance on the sale. If the deal goes through as planned, your good faith deposit will fold into your down payment. And putting earnest money on the table can give you a little breathing room to finish getting your financing in order.
If the sale does not go through and your purchase contract has protections in place (like inspection and finance contingencies), you should be able to get your earnest deposit back. But making sure that everything is in writing in your purchase agreement is the best way to protect yourself.
#2 Sellers rarely accept offers without a good faith deposit.
When you put in an offer on a home, it will include the amount you have available for your earnest funds. If the sale process didn’t require earnest money for a house deposit, potential buyers could make as many offers on as many homes as they liked. Then they could mull over their choices.
While that sounds great for buyers, that would essentially take the home off the market while the buyers debated the merits of the home. That’s not feasible for a seller who needs to attract interest, offers, and close on a deal. Earnest money — protects both the seller and the buyer.
#3 Earnest money real estate deposit is 1%-3% of the purchase price.
Factors that influence how much your good faith deposit include regulations in your state and the seller’s preferences. The temperature of your local real estate market makes a difference too. In a hot seller’s market, a larger earnest money deposit may be expected. On the other hand, a smaller amount of earnest funds could be acceptable in a cooler buyer's market.
And just like an offer over the asking price, a larger good faith deposit can sometimes tip the odds in your favor. That's especially true if your seller sees a lot of interest in their home.
#4 Your lender will verify the source of your earnest money mortgage deposit.
Lenders want to know that this money really does belong to you and accurately represents your ability to fund a home purchase. When you fill out your loan application, you'll also be submitting your most recent bank statements. So, you should be able to show that the money has been in your account for at least 60 days.
Sometimes a relative or close friend offers to give you money to help buy your home. So, if the earnest money comes from a gift, you’ll need a signed gift letter. The letter will need to include the amount of the gift, the relationship of the donor, and that they do not expect repayment.
#5 What happens to your good faith deposit if the sale falls through?
Sometimes a deal can fall through. When that happens, it's often because the inspections uncovered something that was not acceptable to the buyer. Or, maybe the appraisal came in low, and the seller isn't willing to negotiate the price.
That’s why you want to make sure you’re working with a knowledgeable realtor who knows how to protect your interests. Make sure you read the sales contract to see under what circumstances you can get your earnest money for home purchase back.
If things don’t work out, the good faith money (real estate deposit) can go to whichever party was not responsible for pulling out of the deal. It depends on the circumstances. You will usually get your earnest funds back if your lender declines your financing or if the home inspection turns up any problems. A nominal cancellation fee can be deducted in either case.
#6 Never give your good faith money directly to a seller.
Make sure your money is held in escrow and is going into an escrow account. Work with a reputable title and escrow company. Don’t give your deposit money directly to the seller. You’ll have no protection and no way of getting back your funds if the deal doesn’t go through.
That’s also the case when you’re buying a For Sale By Owner (FSBO) property. Even though you’re dealing directly with the seller, you still want your earnest money deposit to go to a neutral third party like a title company.
We hope this information about earnest money and how to protect your interests was helpful to you. The home loan process has many steps, and understanding good faith deposits is vital for your success.
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