Whenever you formally make an offer to purchase a home, it is customary to pay an earnest money deposit. This is a sum of money showing the seller your good faith that you are going to adhere to the terms of the contract and purchase the property.
It is important to understand exactly how your earnest money is handled between you and the seller. I will answer the most common questions I receive from my clients in order to help you to be better informed as to:
What is the purpose of your earnest money and what does it represents in the process of purchasing your next property?
Who should you pay your earnest money to?
How do you protect your earnest money deposit?
Under what conditions and when do you get your earnest money back?
What is the Purpose of Earnest Money?
The purpose of earnest money is to show the seller your good faith to buy the property. The earnest money is held in escrow and applied to the purchase/closing costs on the day of closing. This means that when you as the buyer make a contract with the seller and then all of the contingencies are removed and you don’t close on the contract, you forfeit your earnest money and the seller keeps it as damages. I like to explain earnest money as the seller’s assurance that the buyer will actively work to see the purchase of the property through to the finish line and won’t be tempted to continue to look for something better.
I mentioned damages – you may have asked yourself, “how can the buyer cause damages when they don’t have possession of the property?” From the side of the seller, when the buyer enters into a contract with them, they are agreeing to take their home off the market and allowing the buyer to perform due diligence including inspections and an appraisal. If the buyer has passed all deadlines and decides not to close, the seller would receive the earnest money deposit as damages for having taken their home off the market, preparing to move, etc. and then having to change their plans and market their property again.
How Much Earnest Money Is Required and When Do You Pay?
How much earnest money should you offer? The question really should be how serious of a buyer do you want to appear to the seller? There is not a set amount required for earnest money - it can literally be $1 dollar, or it could be $100,000 dollars. It is up to whatever the buyer and seller agree to. The repercussions for not performing on the contract are that you forfeit the earnest money to the seller. My recommendation to buyers is to offer between 1% and 3% of the purchase price as this will show the seller that the buyer has a significant amount at risk if they do not perform. It is also noteworthy that most sellers are typically more interested in how quickly a buyer can close than how much earnest money is offered. This is where an experienced Realtor can assist you to structure the best offer so that you stand out above the rest – especially in a hot seller’s market like we see right now.
One key item to be aware of. In Utah, earnest money is due immediately and your agent must turn it into their broker within 4 calendar days of the accepted contract.
Who Holds the Earnest Money?
First and foremost, earnest money should never be given directly to the seller; instead, the money should be deposited by your broker into a monitored account to ensure that not only is the money safe, but the rules that govern earnest money deposits are followed.
The Real Estate Purchase Contract (REPC) sets forth the guidelines of where the earnest money is held when it says, “After Acceptance of the REPC by Buyer and Seller, and receipt of the Earnest Money by the Brokerage, the Brokerage shall have four (4) calendar days in which to deposit the Earnest Money into the Brokerage Real Estate Trust Account.”
If a buyer chooses to not have the earnest money held in the seller’s Brokerage Real Estate Trust Account, they can elect to deposit it with a title company or an attorney. This must be disclosed in writing and agreed to by both the buyer and the seller.
What Happens to the Earnest Money if the Contract is Cancelled?
When I am working with buyers, I have a process in place to make sure my clients are never in breach of contract. I make sure they want to move forward with the purchase, we have the approval and okay from the lender, the property has appraised for the offer price, and if any additional negotiations are needed due to discrepancies that arose during the inspection, that those items have been resolved. I make sure that my clients understands that if after all these deadlines/contingencies have passed and they choose to cancel, only then do they risk losing their earnest money. In all reality, my client’s earnest money should never be in jeopardy.
As I summarized above, the REPC sets forth provisions by which the contract can be cancelled, and the buyer can receive a return of their earnest money. These provisions are known as “contingencies”. There are three specific contingencies set forth in the REPC, however a buyer or seller can specify other contingencies while negotiating. The time in which a buyer must resolve these contingencies is known as the “Due Diligence” period and are explained below:
Inspection Contingency – the buyer is happy with the condition of the home and any concerns after the inspection have been resolved.
Appraisal Contingency – the home has appraised for at least the amount of the offer – if not more.
Financing Contingency – the lender has fully approved the loan and communicates that with you.
If the property does not appraise for the purchase price, or if there items that came up during the inspection that you feel need to be fixed and you are not able to renegotiate with the seller, then you can cancel during this due diligence period and you are entitled to receive your earnest money back. If all these deadlines have passed and you choose to cancel, then you will most likely not receive your earnest money and the seller will be entitled to take this for having taken their property off the market.
I hope this information about earnest money helps to clear any confusion you have about this step in the home selling or home buying process. These and other tips are all items that I go over with my clients whether you are just preparing for the future or actively looking to buy or sell your home. Please reach out to me at any time at (801) 885-2558 or by email at brandonrwood19@gmail.com and let’s work on your personal plan!