Earnest money is a deposit that a potential buyer makes to signal the seller that they have a serious interest in a property. This money is also known as a “good faith” deposit and is used to benefit both the buyer and seller during the buying process.
Buying a home involves a number of financial transactions, such as: For example, saving for a down payment, securing a loan, and paying closing costs. Serious money is another expense associated with buying a home. However, it has the additional role of protecting buyers and sellers from some of the risks associated with a real estate transaction.
- If the Purchase failsSerious money helps sellers regain lost time when the house was no longer on the market.
- If the Contract conditions are not met, serious money is often refunded to the buyer.
- If the Purchase is successfulThe serious cash deposit is applied to the down payment for the house.
Read on to learn all about how serious money works, how it benefits buyers and sellers, and what those deposits look like in different situations.
How serious money works
When a buyer is serious about buying a property, they are using serious money to signal their intention to buy. Although the deal is still ongoing at this point, a substantial deposit of funds often causes the seller to accept an offer, thereby changing the listing status to “under contract”.
While the amount of money needed varies, it is often 1 to 3 percent of the total cost of the house. While serious money isn’t always required, most sellers prefer to deposit to find serious deals, and in highly competitive markets, a larger deposit offers a chance to stand out in a crowded field of offerings.
When a buyer makes a serious cash deposit, the funds are transferred to an escrow account. This means that a third party will keep the money safe until an agreement is reached. After the house is closed, the money will be used for the deposit.
The real value of serious money, however, comes from the way it benefits both homebuyers and sellers.
When will serious money be refunded?
In situations that do not go according to plan, serious cash deposits can be refunded to protect buyers from various risks.
After the down payment, a buyer and seller enter into a contract to begin the process of changing ownership. This contract describes several contingent liabilities, which are conditions that must be met before the contract can be considered binding.
If either of these conditions is not met, the contract will fail – and in some cases the buyer will receive a refund for their serious cash deposit.
A home buyer will be refunded for money earned in the following situations:
- If the The estimated value of the house is lower than the costthe buyer can exit the sale with his down payment.
- If the House fails inspectionthe buyer can choose to exit the sale with their deposit or negotiate a lower price based on the cost of the repair.
- If the Buyer cannot secure a mortgage For the cost of owning a home, they can cancel the contract and claim their deposit back.
However, all of these situations are only covered if these contingent liabilities are expressly stated in the contract. So read it carefully before signing. In any case, it is very helpful for home buyers to know that their deposit is refundable in situations where the contract cannot be performed by the seller.
Earnest cash deposits also benefit sellers who take a risk in entering into contract negotiations with a buyer.
How serious money benefits sellers
The most obvious way that serious money goes to sellers is by giving a clear signal as to which buyers are serious. However, there is an even more important way that serious cash deposits protect sellers during a property sale.
After a potential buyer makes an acceptable deposit, the seller will usually start negotiations. As a result, the listing for the home changes to “under contract,” which discourages other potential buyers.
If the buyer withdraws from the sale, the seller has lost time to show the home to other buyers and may have to pay additional costs to get the home back on the market. However, since the seller receives the serious cash deposit in this situation, he can recoup some of his losses.
While these deposits may seem onerous at first, they ultimately benefit everyone involved in buying or selling a home.
Examples of earnest money deposits
To really understand how serious money works, it can be helpful to imagine some of the key scenarios that arise after making a deposit.
After a buyer has made a serious cash deposit and contract negotiations begin, there are three typical situations:
- The buyer withdraws: If the buyer withdraws from the sale, the seller keeps the serious cash deposit.
- The terms of the contract are not met: Conditions that are not met – such as the contingency of home inspection or the contingency of appraisal – result in an invalid contract, allowing the buyer to walk away with their earned money.
- The sale ends: If the buyer and seller agree to the terms and the sale is complete, the buyer’s deposit will be offset against the deposit.
As you can see, making serious cash deposits is positive for both buyers and sellers. Sellers benefit because buyers are more committed and financially invested, and buyers benefit because contingent liabilities allow them to move away from a situation that was not what it appeared to be. And when the sale is complete, the serious money is counted towards the cost so that all parties are happy.
Buying a home is an important financial milestone, and understanding how to make serious money is a good first step when buying real estate. To make sure you are on the right track, be sure to adjust your budget carefully before preparing to buy a home. And once you’ve chosen the right place, don’t forget to consider additional costs like renovations or repairs.