If you aren’t sure how your deposit will be handled, ask questions at the time you make an offer. Ask to see the wording in the contract that guarantees the return of your deposit, and addresses how long it will take to get your deposit back. Not every purchase contract affords this type of protection. Learn more about earnest money deposits, how they work, and how to keep yours safe.
What Is an Earnest Money Deposit?
Earnest money is a good faith deposit that is part of the down payment, but it is not the same as a down payment. It is like the buyer saying to the seller, “Yes, I am serious enough about buying your house that I’m willing to put my money where my mouth is.” When a purchase contract is executed, it specifies how much money the buyer is initially putting down to secure the contract—the earnest money deposit—and how much money will ultimately be deposited as a down payment. The down payment is a portion of the home’s sale price paid upfront rather than financed as part of the mortgage.
How Much Is an Earnest Money Deposit?
There is no specific earnest money deposit requirement, but potential homebuyers generally put down 1% to 5% of the purchase price as an earnest money deposit. Keep in mind that the amount of your earnest money deposit depends primarily on your marketplace and local custom. Because there is no set amount, earnest money deposit amounts vary from market to market and across the country. In California, for example, deposits are generally 1% to 3% of the sales price. California buyers do not often put down more than 3%, since most sign a liquidated damages clause that limits the seller to 3% of the purchase price as damages in the event of a default. If it’s a seller’s market, with many buyers fighting over limited inventory, it makes sense for the buyer to put down a larger earnest money deposit to entice the seller to accept the offer. In buyer’s markets, a larger earnest money deposit might entice a seller to accept a lower purchase price. It’s often the market and local conditions that determine how much you should offer as an earnest money deposit.
How to Protect Your Earnest Money Deposit
When making an offer and submitting your earnest money deposit, it pays to be informed. While issues are rare, be sure you give the deposit to a trusted party. If anything seems fishy, talk to a trusted advisor. It’s important to protect yourself and your money from potential scams. In order to protect your earnest money deposit, keep the following tips in mind:
Never give an earnest money deposit directly to the seller. Make the deposit payable to a reputable third party, such as a well-known and established real estate brokerage, legal firm, escrow company, or title company. Verify that the third party will deposit the funds into a separately maintained escrow account. Obtain a receipt. In general, don’t authorize a release of your earnest money until your transaction closes.
How You Can Lose Your Earnest Money Deposit
Typically, buyers can lose their earnest money deposit if they don’t follow the terms of the purchase contract. For example, the contract may specify when inspections need to be completed and when a buyer can back out of a contract. If a buyer waits to get an inspection and then backs out of the contract after the deadline, they may lose the earnest money deposit. However, laws vary from state to state, so be sure to read your contract. In California, for example, standard California Association of Realtors (CAR) purchase contracts allow for the return of the earnest money deposit to the buyer within a specified time period, should they elect to cancel the transaction. If, at that point, the seller refuses to return the deposit without cause, they could end up paying a $1,000 civil penalty to the buyer. However, not every agent is a member of CAR in California. Other states may have state-mandated real estate forms.
How Escrow Can Protect Your Earnest Money Deposit
Holding your earnest money deposit in an escrow account can help protect you. For example, suppose your purchase agreement had a home inspection contingency. If the seller agreed to make the necessary repairs but never ended up making them, you could choose to back out of the contract. Because your earnest money is held in the escrow account, the sellers do not yet have your money, and it could be returned to you.
