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Earnest Money Deposit – What Is It And How Does It Help?

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Buying a home is an exciting yet very detailed process that involves a lot of people, paperwork, and money. According to a survey conducted by the National Association of Realtors, 34% of all home buyers are first-time buyers. 

Whether you’re buying a home for the first time, selling your current home, or looking to purchase a new home, it’s important to understand the ins and outs of a good faith deposit.

Read on to learn more about what earnest money is along with some helpful good faith deposit tips so you’ll be able to buy or sell your home in confidence.

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What is earnest money deposit?

An earnest money deposit, also known as a good faith deposit, is a sum of money paid by a homebuyer to the seller as a sign of their commitment to purchase the property.

This deposit shows the seller that the buyer is making a serious offer and intends to purchase the property in good faith. The earnest money deposit helps both the buyer and the seller by providing additional time for important tasks, such as title searches, mortgage financing, and property appraisal.

The deposit is typically given when the sales contract is signed and held in an escrow account until the closing date. At closing, the funds are applied toward the buyer’s down payment or closing costs. While the purchase contract doesn’t legally bind the buyer to purchase the home, it does take the property off the market. If the inspection or appraisal reveals issues, the buyer may choose to back out of the deal.

How much should a good faith deposit be?

All earnest money or good faith deposits are negotiable. In most cases, the amount will range between one and two percent of the home’s purchase price. If the local housing market is hot, earnest money deposits may be as high as between five and 10 percent of the sale price. 

Most sellers prefer to get a fixed amount like $3,000 or $8,000. If a buyer is very serious about purchasing a specific home, they’ll usually offer a higher amount to show the seller that they’re interested in following through with the transaction.

Offering a good faith deposit is part of a buyer showing good due diligence. If the closing process is prolonged, some sellers may ask for continuing earnest money deposits until the date of closing. If the buyer fails to make these additional deposits, the seller could decide to return the property back to the market.

If you’re ever in doubt about how much your good faith deposit should be, talk to your real estate agent. They will work with the seller’s agent to come up with a reasonable number.

Good faith deposit tips

When you pay your earnest money deposit, it will go into an escrow account or a trust under a third party, like a real estate attorney’s office. The good faith deposit may also go to a real estate broker or directly to the title company so that it’s in good hands.

Earnest money may be paid via personal check, wire transfer, or certified check. You cannot use a credit card to pay for a good faith deposit. Make sure that you get a copy of the sales contract and that it clearly shows the amount of earnest money you paid.

Your agent should also give you a copy of the check or wire transfer for your records so you have proof of payment. Remember that the funds will stay in the escrow account or trust until closing.  

Good faith deposit guide: refunds

There may be times when a deal is canceled and your earnest money will be refunded. If the seller cancels the sale without a valid reason, you will get your money back in full.

If your home inspection reveals serious or very expensive defects, you also have the right to cancel the sale and get a refund. In cases where the appraisal amount is lower than the sales price and the seller won’t negotiate, you’re also off the hook.

Sometimes, home buyers run into issues securing financing. If you can’t get a mortgage loan approved, then you should be able to get your good faith deposit back.

The buyer may be unable to sell their home before they can close on their new one. In cases where this specific contingency was already agreed upon, unfortunately, the deal might not go through and you’ll also get a refund. 

Always go over the fine print and all contingencies of your contract with your real estate agent. An experienced real estate attorney can also help you understand the terms and conditions to make sure that you’re protected. 

If something happens that isn’t specifically listed in your contract, then you may lose out on your good faith deposit. Things like simply changing your mind about the home at the last minute aren’t grounds for a refund in most cases. You could also lose your earnest money if you fail to adhere to timelines, such as failing to get the inspection in a timely manner.

Protecting your good faith deposit

Earnest money protects the seller from losing out if a buyer backs out of a potential sale. However, there are things you can do as a buyer to protect your good faith deposit, too.

Always make sure that there are contingencies in place for things like home inspections and financing in the contract. If they aren’t there, then the buyer may get their money back and the seller will lose out.

Get all contract terms and any contract amendments in writing and never sign anything until you fully understand what you’re reading. This applies to buyers and sellers. Consult with your real estate agent or an attorney if you need help clarifying what the different terms mean for you.

Make sure that you always abide by the terms of your contract. This means you must get the appraisal or home inspection done by the date listed and meet all of the contract terms or you could risk losing your good faith deposit. 

Never send your good faith deposit directly to the seller. Always use an escrow account or a trust to hold the funds. The money will be released to the seller during the closing, or back to you if a refund is warranted.

Your good faith deposit should be made to a reputable third party like the title company, a real estate brokerage, or a real estate legal firm. Never write a check or wire transfer directly to the seller. You should also always make sure that you get a receipt so that you have a record of the transaction in case an issue arises.

Good faith deposit explained: an example

Here’s an example that may help with understanding a good faith deposit and how it might work. Let’s say John wants to buy a home from Susan that’s worth $150,000. John’s broker arranges a good faith deposit of $15,000 that will go into an escrow account.

Both the buyer and seller sign a sales agreement and it states that Susan, who is now living in the home, must be completely moved out within three months. Susan realizes later that she can’t find a new home before the date of closing. In this case, John is allowed to cancel the sales offer and will get his good faith deposit refunded back to him.

The deposit has earned a bit of interest during this period. As long as the interest amount is under $600, John can keep the total amount without having to file a form with the IRS. 

Start the process today

Offering sellers a good faith deposit is a good way to get the home you’ve always dreamed of. Remember to keep these tips in mind so that your money is protected and so you can seal the deal on closing day.

If you’re a seller interested in getting a cash offer on your home, find out how much your home is worth today by creating an account on iBuyer.com and getting a no-obligation cash offer.

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