And how much should I spend on it?
WHAT IS EARNEST MONEY?
Let’s begin by talking about what earnest money actually is. According to the 10th edition of Washington Real Estate Practices, it is traditional for the buyer to give the seller earnest money as evidence of the buyer’s good faith intention to buy the property on the terms they have offered.
There’s no law that requires a buyer to give the seller an earnest money deposit, but virtually every seller will expect one. A seller does not want to take their home off the market for weeks, possibly months, unless the buyer is actually going to follow through on their promise to buy the property. Since the buyer will usually forfeit the deposit if they back out, the deposit gives the seller some assurance that the buyer really is ready, willing, and able to buy the property.
HOW MUCH SHOULD YOU DEPOSIT?
There is no “standard” amount or percentage. In fact, the size of the earnest money deposit usually depends on the buyer’s circumstances. A buyer who is planning on making a large cash down payment generally won’t have any trouble making a substantial deposit; the deposit will simply be applied toward the down payment when the sale closes. On the other hand, if the buyer is planning to finance the purchase with a no-down payment VA loan, they may not have enough cash for a big deposit.
As a general rule, the earnest money deposit should be large enough to give the buyer an economic incentive to complete the transaction. It should also be large enough to compensate the seller for the time and expense involved in taking the house off the market if the buyer fails to complete the transaction.
Now that you know what an earnest money deposit is and have an understanding of how much to deposit, let’s talk about the advantages and disadvantages of the different forms of payment an earnest money deposit can take.
Personal Check: Most buyers make their earnest money deposit with a personal check. The check is usually made payable to the escrow agent (Title Company). If you don’t have personal checking, you can purchase a cashier’s check or a money order at a local bank or grocery store.
Cash: In rare cases, a buyer wants to make the earnest money deposit in cash. Cash earnest money deposits carry larger risk and most brokerages won’t accept cash deposits.
Promissory Notes: Although it is risky to accept a promissory note as an earnest money deposit, sometimes a seller is willing to do so. If buyer fails to pay the note when it comes due, the seller can sue for breach of the purchase and sale agreement and buyer will be held responsible for paying reasonable attorney’s fees and court costs.
Personal Property: In unusual cases, a buyer may want to use an item of personal property as an earnest money deposit. For example a buyer may wish to use stock certificates, bonds, or a classic car as part or all of the deposit. It is up to the seller to decide whether to accept such an item as a deposit.
CAN I LOSE MY EARNEST MONEY?
YES!
If the buyer and seller have signed a purchase and sale agreement, but the sale fails to close, the earnest money will either be returned to the buyer or forfeited to the seller. The circumstances under which it will be refunded or forfeited should be stated clearly in the purchase and sale agreement. This is the best way to prevent a dispute between the buyer and the seller over who is entitled to the deposit.
Typically, the buyer is entitled to a refund of the deposit if:
*the seller rejects the offer
*the buyer withdraws the offer before it is accepted
*the buyer rescinds based on information in the seller disclosure statement or discovers a material inaccuracy concerning the property
*the seller accepts the offer, but a contingency provision is not fulfilled, so the contract is terminated.
On the other hand, the deposit will generally be forfeited to the seller if the seller accepts the offer, but then the buyer simply changes their mind and backs out of the sale. Most purchase and sale agreements provide that the deposit will be treated as liquidated damages if the buyer breaches the contract.
In Washington, when a buyer’s earnest money deposit is treated as liquidated damages, the amount that the buyer forfeits cannot exceed 5% of the purchase price of the property.
WHERE DOES MY EARNEST MONEY GO?
Once you deposit your earnest money at the title company, it is usually held in an escrow account until you close. If you make it to closing and get the keys to your new home, your earnest money is applied as a credit toward your down payment and closing costs.
Have more questions about earnest money and what it means to you? Get in touch with me today to schedule your free, no obligation buyer’s consultation where we will discuss all things buyer related in real estate.
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source: Tenth Edition Washington Real Estate Practices