Why Do I Need Earnest Money?
When you are purchasing a home the amount of money for a loan application, a home inspection, actually anything and everything you have to pay for can feel very overwhelming. The days of low to no down payments are largely past and markets everywhere seem to be running thin on inventory, earnest money may well be the most important negotiating tool you’ve never heard of.
What Is Earnest Money?
When you make an offer on a home, part of that offer can include a little show of good faith on your part, in the form of cold, hard cash (well not actual dollar bills… you can write a check or send a wire). Generally, one to three percent of the offer price is pretty normal for an earnest money deposit. However this can vary widely based on market conditions. The more you put up, the more serious you appear to the seller. But what happens to that money?
Earnest money is literally just a show of faith. When you go to the closing, it is credited towards the cash you need to close, which is made up of line items like your down payment, your closing costs, and your prepaid items. It will simply be applied in full as a credit in your closing documents, reducing the amount of money you need to bring with you on the big day.
Here’s the one thing to be cautious of; if you were to default on the contract, the seller may be entitled to some or all of that earnest money. However, plenty of situations exist where you can cancel, and your earnest money will be refundable, such as:
An unacceptable home inspection. This all has to be stipulated in your contract; there are no givens in a real estate transaction, but there are things that are reasonably standard. Having an unacceptable home inspection, if the seller is not willing to make reasonable repairs, can be a cause for terminating the contract and getting your earnest money back.
Your financing falls through. Again, you’ll need a financing clause or addendum to ensure you’re covered in this event, however, because financing is so important to real estate transactions in general, they are pretty standard. If your financing falls through due to no fault of your own (you’ve been laid off, your bank closes, a co-borrower dies), you should generally be able to reclaim your earnest money. The specifics will be in your real estate sales contract, so pay close attention (and hire an agent who will pay closer attention).
The seller can’t close. There are a few rare situations where a seller can’t close the transaction. These are incredibly uncommon, but they do happen once in a while. For example, you might find out that the seller only believed they were the owners of the home. This can occur when a parent dies without a will, forcing the property into probate court even when it’s clear an only child will be the sole heir.
And in the case that the seller can close, but chooses not to for whatever reason, you would be entitled to get your money back or, in many cases, you can force the seller to honor the contract.
What Is an Earnest Money Note?
In some markets, you may have an additional option for earnest money, known as an earnest money promissory note. This is essentially an IOU that accompanies the offer. On the note, you’ll specify exactly when you’ll either turn the paper into actual cash or forfeit the offer entirely. Though these were once very common, they’re far less so today. If you choose to use an earnest money promissory note, be sure to describe in great detail why you’re not able to provide earnest money on the spot and how you will remedy this.
For example, if you have some stocks you were going to cash out for your down payment, but didn’t want to touch until you were really ready, you may need time to sell enough to cover the earnest money. In that case, specify this as the reason and say that you’ll initiate a sale on a certain day, then convert the note on that day. Make sure to leave yourself a little leeway, because if you fail to perform, you can suffer serious consequences.
Generally speaking, earnest money promissory notes can be considered a sign of a weak offer, so you should inquire before taking that leap.
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Choose to have an amazing day…. Jeff