What is earnest money in a real estate transaction?
Earnest money is a deposit of funds made by the buyer immediately after an offer to purchase property is accepted by the seller. This deposit is typically made to a third-party (usually a title company) that holds it in a trust fund until the contract terminates or closes. At that point, the funds are dispersed according to the parameters set forth in the contract.
These earnest money funds make known to the seller that the buyer is acting on good faith to do what they can to follow through and purchase the property. It also helps encourage the buyer to do their due diligence on time since they risk losing this money if they don’t abide by and follow the terms set forth in the contract.
How much earnest money is required for a contract to be valid?
As with many terms in a contract, this is negotiable. It will also depend on the type of offer being made, the area the property is located in as well as the market that is in progress at that time – is it a seller or buyer’s market? These should all be a factor in helping you determine what amount to use.
Ex. You are looking to make an offer on a house that is listed at $200,000. The market area is currently a seller’s market – meaning there are more buyer’s than there are houses on the market. The typical earnest money deposit for the area is about $1,000 for every $100,000 of home price. Then, you might can make your offer “stand out from the crowd” of other offers by having a higher earnest money deposit of $4,000-$5,000 instead of what might be a typical $1,000-$2,000.
CAUTION: There are many methods of writing up a strong offer to “stand out from the crowd” be sure that you know the risks involved with this type of offer being accepted and your need to follow through with it once it is accepted. DO YOUR DUE DILIGENCE BEFORE AND AFTER THE OFFER!
Who gets the money if the contract is terminated?
That all depends…
Every contract is different, and the terms set forth in that contract will guide the title company that is holding the funds in the trust on how the earnest money is to be dispersed based on the outcome of the contract. The title company cannot disperse the funds without written permission from all parties involved in the contract. So, the discussion should be made prior to the money being transferred from the trust account as to who gets what.
Start your due diligence immediately following the contract being accepted – DO NOT WAIT UNTIL THE LAST MINUTE! This is where I have seen the bulk of the earnest money get dispersed to the opposite party in a contract – it’s when one side of the transaction either does not hold their end up, or waits until it’s too late to get their part done. Make sure that you are aware of all the clauses and timelines involved in the contract. This will help you protect your side of the transaction from failing to perform and to keep you aware of the duties required of the other side of the contract.
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