What this article is all about:
In an ideal world, if you found the home of your dreams, you and the owner could sign a purchase contract, followed by a handshake and, later, your down payment. In the real world, in order to prove your offer to purchase a property is "earnest," or "in good faith," you need to put money on the table as soon as the ink of your signature dries on the purchase contract.
This earnest money deposit is a fraction of your down payment which indicates the buyer's intent and willingness to execute the agreements laid out in the contract with the seller. The buyer usually pays it in the form of a personal or certified check issued to the real estate brokerage of choice. The deposit will be held in an escrow account, a type of trust fund controlled by both the seller and the buyer, until you successfully complete the closing.
Earnest payment amounts vary widely. The attractiveness of the home's sales price, the level of interest others have expressed in the property, and how quickly a prospective buyer can move from contract to closing can all influence the sum a seller may request as an earnest money deposit.
How Much Should You Pay?
Some industry experts say earnest money should not exceed 3-5 percent of the purchase contract, while others say 2 percent should be the maximum. Some sellers don't even compute a percentage, but instead ask for flat amounts in the $5,000-$10,000 range.
States set their own legal limits to the amount of earnest monies allowed. Average payments depend on general criteria, such as whether we're in a hot or cool housing market. A buyer who can only make a minimal down payment may have to fork over more earnest money as a guarantee he or she will come through with a mortgage. Another buyer can make his or her offer to the seller more attractive by padding the earnest money.
How Do You Actually Make the Deposit?
In some markets, you won't have to pay the entire sum all at once. When the buyer and seller sign the purchase contract, the buyer can issue a check for a fraction of the initial down payment, usually between $1,000-$5,000, which will be followed by payment of the remainder of the earnest deposit within a week. During that period, a buyer can hire a home inspector or attorney to verify the contract.
Once the seller and the buyer both have signed the contract, the buyer should issue a check for his earnest money deposit to an escrow account, which is held by a real estate brokerage. That means you make out your check to a real estate brokerage, not an individual.
State real estate laws strictly regulate how real estate brokers conduct and manage these separate, professional escrow accounts. Brokers are not allowed to deposit any earnest monies in their own business bank accounts.
Nevertheless, make sure to request a receipt for any earnest money handed over to a real estate agent or a brokerage. It should come in the form of a copy of the check on the brokerage's letterhead along with a signature of the person accepting the check's delivery and the date and location the check was received. If you're in a hurry to close on your purchase, be aware that a quick closing date requires a certified check for earnest money.
Just like any other money deposited in a bank account, your earnest money is an investment that can earn interest in its escrow account. If it amounts to more than $5,000, you'll have to fill out IRS Form W-9 to receive the interest.
Something Went Wrong, How Do I Get it Back?
If you can't secure the necessary down payment or mortgage loan to buy the house of your dreams even though you signed the purchase contract, you may need to forfeit some of your deposit. The home seller took the house off the market for you and now he faces the loss of valuable time and money due to your default on the contract.
Although most purchase contracts stipulate that a seller can keep the earnest money deposit if a buyer fails to complete the purchase of a home, the seller and the buyer can find a fair solution on how to distribute the earnest money deposit between them.
Hope that if something goes wrong early in the process, the seller will surrender his claim on the deposit and return it to the buyer, after a small cancellation fee is subtracted by the brokerage. If all else fails, be prepared to write the money off as a penalty for having caused the seller some hardship, but such a sad scenario is the exception, not the rule.
It's important to know that this earnest money deposit is not an extra cost of buying a home. It will be credited towards the down payment at closing, and in case it exceeds your mortgage down payment, you will receive the balance at closing.