Did you just find your dream house with everything you were looking for, but haven’t quite secured some financing yet? Or maybe you just need some time to get your insurance sorted out, but you’re scared you’ll lose the house you spent months looking for. If you need some extra time to help get situated before buying your dream house, you should consider making an earnest money deposit.
What is earnest money?
Earnest money is a deposit you make in good faith to the house’s seller to secure the house as your own. With earnest money, you’re showing the seller that you are committed to purchasing the house and the seller can safely remove it as an active listing. Once you secure the home with earnest money, you can get more time for the closing process.
How does it work?
Earnest money deposits are given to the seller of the house once you are confident you will purchase it. They will typically amount to 1-3% of the house’s selling price, so an earnest money deposit on a $400,000 home would be about $4,000 to $12,000. You should negotiate this amount with the seller because depending on how popular the home is, you can get away with a much lower deposit.
Protect your deposit
Once you give the seller earnest money, there are only a few scenarios where you can get a refund without completing the transaction. These scenarios are included in a contingency clause as part of your purchase agreement. One of the most common contingencies is called the financing contingency. As the name suggests, if you were pre-approved for a mortgage, but your financing fell apart while closing on the purchase, this contingency ensures that you are not punished. If you can’t get this one and want to secure a lender with little risk, then you should consider getting an FHA government-insured loan or some other loan offered by a government-sponsored agency. Similarly, the appraisal contingency activates when an unbiased appraiser values the home as lower than what it was listed as, which can cause your mortgage lender to pull your financing. If you have these contingencies, you remove any of the risk associated with your lender from earnest money because you will get a full refund.
One last important item you should ask for if it’s not provided is the inspection contingency. This clause ensures that if a home inspection reveals significant damage or issues with the home, you can leave the transaction and get a full refund on your earnest money deposit. Unfortunately, there is some risk associated with buying a home in general, so make sure you don’t lose your expensive deposit because you were deceived by the seller.
If any other scenario arises and you do not have a contingency clause in your purchase contract, you can still back out of the deal, but you will lose your earnest money deposit. This is what gives sellers peace of mind when taking a risk on a buyer.
Is earnest money worth it?
It may seem risky giving the seller money upfront before you even purchase the house. But if you have the right contingency clauses in your contract, you should be safe. If you’re truly uncomfortable with the idea of paying someone before you can purchase the house, then rest assured that an earnest money deposit is not required by law. Instead, it’s a show of good faith to secure some level of trust between you and the seller. You give them money to show you’re invested in the home purchase and they remove the listing to give you exclusive purchase access.
It’s also important to keep in mind that you are not losing the money you give to the seller for an earnest money deposit. A deposit is something that you put into the purchase of the home. Once you close on the deal, you can ask for a refund or you can use the money as part of your down payment, to pay for closing costs, etc. The money is still yours after you purchase the house. If you are serious about purchasing the home, then putting down an earnest money deposit is a smart move. You can secure the home while still taking your time to ensure the purchase is as smooth as possible.