What You Need to Know About Earnest Money

What You Need to Know About Earnest Money

You’ve just bought a new house – congratulations! So many things to think about, one of them being your earnest money.

What is Earnest Money?

Basically, your earnest money is delivered on or around the time you submit a contract to purchase your new home. It’s the way you say that you are serious about this house – that’s why it’s also called a “good faith” deposit. Without a financial commitment, how does the seller know that you’re really interested in their home and not five others?

How Much Earnest Money Do You Need to Put Down?

This question will vary from state to state and even region to region. When I first started in the business in 1998, the earnest money was 10% of the contract price. With the vast upswing in prices we saw running up to the recession, the number now hovers at around 3-5% but it can be higher or lower.

And you can also offer to pay a flat fee not dependent on the price of the home. It would need to be accepted by the sellers, as would all other parts of the contract.

In the Chicago North Shore towns of Winnetka, Wilmette, Kenilworth, Glencoe, and Northfield (and actually the wider Northern Illinois area) the earnest money payment is made in two installments. 

Our local contract (the Midwest Real Estate Data) stipulates that an initial amount is tendered within a day or so of the contract signing (it’s called the initial earnest money). It used to be that the check was attached with the contract but that was done away with. That amount is usually between $1000 and $5000. 

After the contingencies have been met – usually the house inspection and attorney approval of the contract (we typically use attorneys here) the balance of the earnest money is due (this is called the balance of the earnest money). A $500,000 contract with a $2500 initial earnest money would require a balance of $22,000 ($500,000 x 5% = $25,000 – $2500 = $22,500.)

The total earnest money delivered is on the final negotiated price, not the offer or list price – if you’re using a percentage of the price.

Where Does the Earnest Money Go?

Large brokerages set up an escrow account for you and deposit the money. There are very strict rules regarding this. New buyers are often confused about this since they’re they’re working with a lender to secure a loan and then this thing called earnest money comes up.

Ultimately, the earnest money will be applied toward your closing costs, the loan, or will be returned to you after closing

Years ago, buyers were able to reap a small check at closing because the earnest money accrued interest during the escrow period. That was all but eliminated with rates being exceedingly low and not worth the effort to write the check.

Smaller brokerages, independents, and some discount brokers do not hold earnest money. They will usually be able to have the seller’s attorney set up the escrow account in the same manner that a large brokerage would.  

Do I Get My Earnest Money Back if I Cancel the Contract?

It depends. In the North Shore suburbs the answer is usually yes but I have seen buyers default on the contract and lose their earnest money.

Your initial payment is always refunded if the house has inspection issues that cannot be resolved, the house doesn’t appraise, or you can’t secure a mortgage. There is a time limit on all contingencies as per the contract but always check with your real estate agent about the dates.

In this competitive market we’re seeing buyers who are agreeing to nonrefundable earnest money if the deal falls through – regardless of the reason. That’s a risky strategy but understandable with the current low inventory.

Our local contract is very specific and deciding that you paid too much is not a valid reason to cancel it. If you are still within the time frame of the inspection/attorney approval time period (which is usually 5-10 business days), you will be able to cancel your contract and get your initial money back if you want out.

After all contingencies – but the mortgage – have cleared, you are now going to deliver the balance of the earnest money. If you are not able to get a mortgage, this contingency will allow you to get your earnest money back.

It’s muddy waters after that. I know of buyers who have defaulted on their contract after contingencies were met and were given back all their earnest money while others didn’t.

I recently saw a luxury home close on a Friday and be relisted at the same price on Monday. I can only think that the buyers changed their minds, had an illness, or the new job was canceled. They couldn’t get out of the contract and now they’re selling the home they never lived it. All conjecture on my part but it does beg the question of why would they do this?

Whether you are a buyer or seller, make sure you discuss the nuances of earnest money with your real estate agent. Each side assumes they get to keep all the earnest money and the buyer usually does, but there are exceptions.

And remember, everything is negotiable.

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