Quick Takeaways on Earnest Money in Real Estate

  • The escrow process is designed to protect buyers and sellers during real estate transactions.
  • Earnest money is a payment from the potential buyer to the seller to show good faith in their intent to complete a real estate transaction.
  • If the buyer’s offer is accepted, earnest money goes toward the down payment and closing costs. If the sale falls through, buyers may be able to get some of the earnest money back depending on the circumstances.

Losing earnest money is a hurdle in the homebuying process no homebuyer wants to face, but following the ten rules provided by Endpoint, as well as researching the topics on the rest of this page, should help put your earnest money deposit to good use!

What is Earnest Money?

Earnest money refers to a payment made from a hopeful home buyer to the home seller to show a serious commitment to buying the house. This payment is separate from the down payment, though it does usually get applied to the total down payment cost. Earnest money is placed in an escrow and is seen as a token of good faith from the buyer.

How much earnest money should a buyer pay?

Earnest money is often around 3% of the purchase price, or a rounded number like $5,000. It's important to note that the amount of earnest money depends on the market and the seller's request. Sellers may need to offer more earnest money in a competitive market, but a lower sum may be acceptable when there's not much demand. Offering a higher sum in earnest money may mean the seller is more likely to accept or be flexible on other terms.

Understanding the loan-to-value (LTV) ratio is valuable, as this ratio is calculated by dividing the loan amount by the property's appraised value. This determines the maximum amount a lender will finance which directly impacts how much earnest money a buyer may need to put down. A higher LTV ratio often requires a larger down payment to secure favorable mortgage terms, including interest rates and required mortgage insurance .

For first-time homebuyers, it can be daunting to come up with the necessary funds. Fortunately, there are options like first-time homebuyer loans and grants that can assist in covering initial costs. These resources often provide financial support through down payment assistance programs and low-interest loans offered by government agencies or non-profit organizations.

Can buyers lose their earnest money?

Unfortunately, each step in closing on a home, including escrow, is an opportunity for fraud. In the era of wire transfers, closing information sent via email, and online banking, you can never be too safe when depositing and/or transferring your money. If a fraudster convinces you to wire them money via a duplicate email address, there is often little you can do to get it back. Always confirm information and transfer deadlines with your bank, lender, and any other parties involved.

Though third parties are supposed to make the escrow process unbiased and safe, mishandling can occur. Unfortunately, large companies can make mistakes when distributing escrow, and dipping into company or customer funds is not an unheard of crime in the real estate world.

See References for more information.

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