An earnest money deposit is a common term in the real estate market. It refers to a check drafted from the buyer's bank account. The check can be a personal check or a cashier's check and is issued to the broker or title company. The money is held by the broker or title company in a trust account as a monetary commitment to demonstrate earnestness on the part of the buyer to purchase a specific piece of property.
When the property purchase is completed, there are three ways the earnest money can be handled. The money can be applied to closing costs or a down payment, credited to the buyer, or forfeited to the seller.
Earnest Money Deposit Determination
The amount of the earnest money deposit depends on a variety of factors. When sellers place their property on the market, they can determine the amount of earnest money they will request in conjunction with their real estate broker. This determination will be placed in the property listing in the multiple listing service.
This amount typically runs from 3 to 5 percent of the total purchase price. When an offer is put in on a piece of property, the potential buyers can offer a reduced earnest money deposit. This offer must be reviewed and accepted by the seller before the contract is active. The amount of earnest money will depend on the closing period, amount of down payment, interest level in the property or the value of the offer.
Deposit Approach to Earnest Money
At the time of closing, buyers will be required to contribute a down payment. The amount of this down payment depends on the type of loan and credit history of the buyers. Conventional home loans require anywhere from 3 to 20 percent down.
During closing, the earnest money deposit can be used to reduce the amount of down payment. For example, if you are buying a home for $200,000 and want to put 20 percent down, your down payment will be $40,000. If the earnest money deposit is for 3 percent or $6,000, you would be required to provide a down payment of $34,000.
Credit Approach to Earnest Money
The second way to handle earnest money deposits is a credit approach. If you are closing on a property, you have the option of providing the entire down payment to the title company. After the property is closed and recorded, you can request that your earnest money deposit be credited back to you. A check will be issued by the holder of the trust account.
Breach of Contract
The final scenario involving earnest money deposits is a breach of contract. Any real estate purchase includes a contract with specific terms and conditions which must be met in order to be compliant. The contract will lay out guidelines for specific benchmarks in the buying process such as an appraisal or engineering report.
If the buyers do not comply with the terms and conditions of the contract, they could forfeit their earnest money deposit. The money would be awarded to the buyer or seller, or both, depending on the circumstances of the breach. The amount of the award may be reduced by any fees that were prepaid or charges incurred during the initial stages of the contract.
