What Is Earnest Money?

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    Updated on 6/27/16

    We love working with our clients as they go through the entire home buying process. There are many moving parts and our real estate experience allows us to be of service to our clients as we explain how each part of the process works. One important part of the home buying process is the earnest money and many new homebuyers aren’t clear on how it works. So, here’s a look at earnest money and how it fits into the home buying process. 

    Definition of earnest money

    Earnest money is money paid to confirm a contract. What this means in real estate is that when you as the homebuyer make an offer on a house, that offer is accompanied by a check. This check shows the home seller that you are serious about your offer; that you are a committed buyer.

    Why is earnest money necessary?

    If home sellers take a house off the market after an offer is received, that home is no longer available to other potential buyers. Without earnest money, homebuyers could make offers on as many houses as they wanted to, without committing in any way while they decided which house they preferred. This would not be a good position for home sellers to be left in, which is why almost every offer is accompanied by earnest money. The earnest money protects sellers from frivolous buyers.

    What happens to the earnest money?

    After you write the check, it’s not actually cashed. In fact, you won’t even write it to the seller. Rather, the earnest money check is written to an escrow company and is kept in an escrow account. You will have a certain number of days to complete the home inspection and appraisal while the money is in escrow.

    If everything goes well with the home buying process – i.e. the process moves toward closing, the earnest money is then used toward the downpayment or closing costs. If something turns up during the appraisal or inspection that causes a home buyer to back out of the offer, most of the earnest money can usually be returned. Keep in mind that just changing your mind may not entitle you to a full refund. Refunds are generally only given when inspections or appraisals reveal new information about the home.

    How much earnest money do I need?

    The amount of earnest money needed will vary by state, current real estate market and seller. The most common rule of thumb is to expect to pay approximately 1-2% of the asking price. In real estate markets where inventory is low, buyers may increase the earnest money as a way to entice sellers to accept their offer. To get a better understanding of current expectations in Nashville, contact a local REALTOR®.

    Can I lose my earnest money?

    Short answer: yes. There are basically three main ways to lose earnest money.

    1. First, if you waive contingencies. Financing contingencies say that if your financing falls through, you still get your earnest money returned. Obviously, if you waive that you won’t get your money back. An inspection contingency states that if something major is found during the inspection you can walk away from the deal with your earnest money. Again, if you waive that contingency and don’t like what’s found during the inspection you will be walking away without your earnest money.
    2. Breaching the timeline in the contract. Your contract includes the timelines for you to get an inspection done and financing in place. While most home sellers will allow for a reasonable extension of time, they don’t have to and you could lose both your earnest money and the opportunity to buy the property.
    3. You change your mind. Sellers take an offer with earnest money as a show of your commitment to buying the home. If the inspection is good and financing isn’t a problem but you suddenly have cold feet, the seller does NOT have to return that money.

    It’s important for both home sellers and homebuyers to work with an experienced and qualified real estate agent when dealing with earnest money. The right agent can provide guidance on how much to offer and how to have a purchase agreement that addresses how a refund should be offered. REALTORS® can also recommend reputable title companies for handling the earnest money.

    Are you ready to buy or sell a house in Nashville and need some help with the process? Call DeSelms Real Estate today at 615.550.5565 and work with one of award winning agents!

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