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Earnest Money: What is It and How Does It Work?

Here’s what you need to know about earnest money and its importance in real estate transactions for both home buyers and sellers.

Florida’s May 2021 Real Estate Market UpdateEarnest money is a critical component of real estate transactions and is beneficial to both buyers and sellers. If buying a new home or selling your current one is on the horizon, then it is advisable to familiarize yourself with the importance of earnest money and how it works. Here’s what you need to know!

What is Earnest Money?

The easiest way to think of earnest money is to compare it to a down payment on a vehicle. When a seller accepts an offer on their home, the buyer puts down money to show they are serious and committed to the purchase. It is called earnest money because it is designed to show sincere intent. Less commonly, you may also hear it called “good faith money.”

Importance of Earnest Money

Putting down a couple of thousand dollars or so may not seem like a lot when the home’s purchase price is a couple of hundred thousand dollars. You’re right; it’s not. However, when a seller accepts an offer, they enter into a binding contract. The home comes off the market. This means the home is no longer available to potential buyers.

If the buyer backs out for no apparent reason, the seller must remarket the home and start the process all over again, wasting valuable time and resources. Earnest money is a way to keep buyers honest and prevent them from tying up multiple homes simultaneously and leaving sellers high and dry.

How Much Is Enough?

As a buyer, you do not want to put down too much just in case legitimate unforeseen circumstances arise, and you must walk away and forfeit the money. On the other hand, as a seller, you do not want to accept too little. Industry-standard is between 1% and 3%. In competitive markets, the percentage tends to be on the high side.

Bonus Tip: Sellers are more likely to prefer an offer with a higher amount of earnest money. It shows that the buyer is serious. The more a buyer has to lose by backing out, the less likely they are to do so!

How Does It Work?

Once an offer is accepted, the buyer submits the agreed-upon earnest money, and it goes into an escrow account until closing. If the transaction is successful, the funds can either be refunded or applied to the down payment at closing.

Reasons a Buyer Can Get a Full Refund

Immediately following the beginning of a contract, buyers enter into the due diligence period. The buyer is free to conduct inspections on the property and make sure everything is satisfactory. During this period, the buyer can back out with or without a valid reason and receive a full refund.

After the due diligence period is over, the buyer may still walk away and receive a full refund if other contingencies in the contract are not met.

Reasons a Seller Keeps the Money

The seller keeps the earnest money if the buyer walks away without a valid reason as compensation for the time and money lost while the home was under contract. It must be after the due diligence period and not be a direct result of a failure to meet a contingency. Examples of contingencies include:

  • The appraisal meeting or exceeding the purchase price
  • The sale of the buyer’s home

Earnest Money is Your Insurance

Whether you are the buyer or the seller, ensuring your real estate transaction is protected is of paramount importance. Your real estate agent will help you navigate the appropriate amount of earnest money for the sale price of the house and market conditions.

As the most trusted Realtor in Lake Mary, Gitta sells understands the importance of earnest money. We will help you navigate every step of the home buying and selling process from start to finish. Contact us today to get started!

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