Often times I'm asked what is earnest money and does it really have to be giving during a real estate transaction?
An earnest money deposit (EMD) is money a buyer gives to a seller to show good faith before closing for the purchase of a home.
When the buyer and seller enter into a binding purchase agreement, the seller takes the home off the market while the home moves through the entire process all the way to closing.
The money gives the buyer extra time to secure financing, conduct title search, property appraisal and inspection. Earnest money deposits can range anywhere from 1 - 3% of the sales price of the home depending on the market. Funds are deposited and held in escrow until closing. At closing, the deposit is applied to the buyer's down payment and closing costs.
I recently had a situation to where the deal fell through and the buyers were concerned about losing their earnest money and wanted to know if it was refundable. Earnest money can be refundable in the event it was no fault of the buyer and/or the buyer didn't breach the binded purchase agreement contract.
The following situation are where the earnest money deposit would be refundable:
Home Inspection Contingency:
The home inspection is a very common reason as to why buyers will back out of a deal of purchasing a home. I always encourage my buyers to have a professional home inspection performed to ensure that the home is in livable condition. Should the home inspection come back unsatisfactory, the home inspection contingency protects the buyer and allows their earnest money deposit to be refunded to them. In the event they don't want to back out of the deal, they have the option to either ask the seller to make the necessary repairs or pay for the repairs themselves.
Financing Contingency:
During the pre approval process, there are times when a buyer's lender could run into an issue and the loan is suddenly not approved. In this event, the buyer will have the option to back out of the loan and get their earnest money deposit back as long as it was stated in the purchase agreement. I typically give my buyers around 21 to 28 days to secure financing before their earnest money is at risk. In the event they aren't approved within that time frame, they won't risk losing their money.
Appraisal Contingency:
The appraisal contingency protects the buyer if the property is overvalued. This means if the home is priced too high, but the appraisal came back less than what they home is listed for sale for. Lenders hire third-party appraisers to determine the fair market value of the home and compare it similar homes for sale in the area. If the home is appraised lower than the sales price, the buyer has the option to either move forward or back out the deal without losing their earnest money. Again, as long as it's listed in the agreement.
Contingency for Selling an Existing Home:
Not all buyers are first time homebuyers. Some already own a home and are either moving to a larger home, down-sizing, upgrading or relocating and have existing homes they need to sell before buying another home. This is very common for those who have FHA loans as they are required to sell their existing home before purchasing another. This is where this contingency comes in and if you aren't able to sell your current home before closing, it allows you to back out with your earnest money.
Earnest money explained. It's important to make sure that if something were to happen during your home buying process, you do all you can to protect your earnest money. The best way to do that is to know your options as it relates to your contingencies and most importantly, get them in writing.
Happy house shopping!
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