What is an Earnest Money Deposit?
Do you feel like you need to learn a whole new dictionary of vocabulary as you jump into the home buying process? You are not alone! The real estate industry truly does use a host of words and acronyms and tosses them around as if people use them every day. Earnest money, mortgage insurance premium, appraisal gap, debt to income, these are just a few examples. Yet the reality is, they are NOT common everyday words and I know it can be confusing. Today I am beginning my real estate vocabulary series by answering the question; What is an earnest money deposit? In addition, I will also explore the additional questions of; How much is an earnest money deposit? Once deposited with the title and escrow company, what happens to the earnest money? And what happens to earnest money if the sale does not close?
What is an Earnest Money deposit?
An earnest money deposit is the deposit of funds by a buyer, to a neutral third party, within 3 business days of mutual acceptance between a buyer and seller of a purchase and sale agreement. The earnest money deposit, also known as a good faith deposit, acts as a deposit on the property the buyer is purchasing and demonstrates to the seller that the buyer is serious about buying the home.
How Much Do I Need?
The earnest money deposit varies in amount by each transaction. Here in Oregon, earnest money is typically between 1% – 3% of the purchase price. For example, if you are purchasing a home for four hundred thousand dollars ($400k), the earnest money deposit will normally be between $4000 – $12,000. It is most common to offer 1% when writing an offer. In a competitive offer situation, a larger earnest money deposit may instead be offered as an additional strategy to gain the seller’s attention. Some buyers will choose to put down a higher amount to help convey strength to a seller and stand out above other offers.
How to Deposit Earnest Money
Here in Oregon, the earnest money deposit is deposited with a neutral third party, the title and escrow company. The funds are due 3 business days after buyer and seller have mutually signed an offer. That is unless the buyer and seller have written and agreed on a differing timeline, which is not common. This deposit must be in the form of a check or wired funds, meaning it is liquid money. It is money the buyer has saved. A credit card cannot be the funder of the earnest money, this is a commonly asked question.
What Happens to Earnest Money?
Earnest money sits in escrow until the transaction closes. At closing, the escrow company will apply the funds to the buyers closing costs and down payment. In essence, it is a pre-deposit of final closing funds for the buyer, not an addition. There are times in a transaction in which a buyer and seller will mutually instruct the escrow company to disburse the funds prior to closing. Sometimes the parties agree to disburse the funds to the seller, possibly to show continued good faith if there needs to be an extension to the closing date for one reason or another, or sometimes to a contractor completing necessary repairs. Neither event is overly common, yet they do occur. If this is the situation, the amount of the deposit is still a credit to the buyers closing figures.
What Happens to Earnest Money if a Sale Does Not Close?
Oregon’s sale agreement provides multiple due diligence windows. These windows provide the buyer time to obtain more information about the property being purchased. These windows allow the buyer to back out of a transaction should the property not satisfy their needs. In Oregon we have 5 main due diligence windows in fact. The Inspection, Seller Disclosures, HOA disclosures, Title Report and Financing windows.
The Five Main Due Diligence Windows
The inspection period
This window provides time for a professional hands on inspection of the repair of the home, the sewer line, radon levels, water quality, if the property is not on city water and sewer, and anything else the buyer disclosed to the seller that they wanted to have inspected. This window provides 10 business days from the date of mutual acceptance, for a buyer to verify the condition of the property.
The Seller Disclosure Window
In the state of Oregon a seller must provide a detailed disclosure to the buyer, regarding what they know about the property. The Buyer has a 3 business day window to review this information.
The Homeowners Association Due Diligence
If the home resides in a homeowners association, also known as an HOA, the seller must provide all the documents from the HOA -their rules, regulations, by-laws, accounting of funds, minutes of the meetings etc., to the Buyer. The Buyer has a 5 business day window to verify the rules are satisfactory to their situation.
The Title Report
Here in Oregon, the title department will prepare a report regarding what they find in public records about the home. The buyer has 5 business days to review this report.
If the buyer disclosed in the purchase offer that they are obtaining a loan to purchase, the financing contingency kicks in. Should the financing, for any reason, fall through, the buyer can then back out of the transaction. There is no specific time period on this particular window.
Through due diligence, if the buyer determines the property is not suitable to their needs, the buyer can back out. If withdrawn during one of the specified windows, the buyer can have their earnest money refunded back to them. If a buyer backs out of a purchase transaction outside of one of the windows, the earnest money can be lost and distributed to the Seller. Not to worry, there is no need to memorize these timelines right now. In working with my buyers, I am very specific with my them as we walk through each window of diligence. I guide them through the process in a sense, becoming their calendar for them. I believe many other agents are the same. So to note, though it can happen that a buyer does lose their earnest money, it is VERY hard when working with a professional Realtor.
This should give you a much clearer understanding of the earnest money deposit. What it is, how much is expected and what happens to the money, both at closing, or if a transaction fails to close.