What is Earnest Money and Why do I need it?

Earnest money (EM) defined by Investopidia.com is “a deposit made to a seller that represents a buyer's good faith to buy a home.” This deposit of good-will, given by a potential buyer to the sellers, proves interest and intent to purchase the property for sale. 

It is important to note, earnest money is NOT an additional payment towards your home. In most cases it is 'up front' money that, at closing, is given to the seller and is credited to you as a buyer. If you write a check for your EM deposit it will be held either by a third party, usually the title or escrow company, or the responsible (seller's agent) brokerage. Once your offer is accepted and you close on the property, your EM deposit will be a credit in your final closing documents, your deposit will be put towards the overall purchase price. 

Earnest money provides a few things, but primarily peace of mind for the seller. It communicates that if a seller is going to entertain an offer from a buyer that it will be worth their while. If a potential buyer can write a check for a few thousand dollars, they are most likely in a stable financial situation and can provide the down payment as indicated in the contract. 

EM can also be used to a buyers benefit. In a competitive situation, where multiple offers are presented to a seller, a larger EM amount might indicate to a seller a stronger offer. However, EM is far from the only deciding factor in a competitive market, so be sure to have a thorough discussion with your Real Estate agent on what makes a great offer! 

This leads to a common question; "What is the suggested amount for earnest money?" This is a complex question, that depending on the situation could have many different answers. First off, EM is never required, not legally at least. Sellers can and occasionally, suggest a minimum amount in their listing. If a reasonable amount is suggested, be sure to indicate that in your offer. If no specified amount is asked, 1% of the total purchase price is commonly accepted. 

 What if the purchase doesn't go through? This is a common concern for clients and it's a fair question. There are lots of ways a potential property doesn't go to closing, if a property is appraised for less than expected, if an inspection comes back with a towering list of issues, if your financing is not approved etc. All of these reasons depend solely on what is explicitly written in the contract! There will be clear language in the contract on what happens to EM if these situations arise. If you do not meet the timeframes outlined for responding, there can be some risk involved in making an EM deposit. It's important that you and your agent fully understand what is outlined in the contract to avoid the unlikely scenario of the seller keeping your deposit. 

To recap, EM is a good-will payment a buyer gives to a seller. This indicates their seriousness and intent to buy the property for sale, and can be used strategically to make an offer more appealing. The deposit is typically held with a title company or with the responsible brokerage. Once you close, the deposit is credited to you as the buyer and goes towards your purchase of the property. There is some risk involved in offering earnest money. However, these can be greatly reduced if your agent understands the timeline and language written in the contract. The handling of earnest money is an essential and common process within a real estate transaction, and hopefully I've been able to provide a bit of insight and clarity to the conversation. 

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Cheers!