How Much Faith to Put in Earnest Money?

If you've considered buying a home, or have bought a home in the past, then chances are you've heard about earnest money deposits. Often referred to as a "good faith deposit", earnest money is one method to strengthening your offer, especially in a seller's market.

What is an earnest money deposit?

An earnest money deposit signifies your level of commitment to purchasing a home or property. It serves as a form of security deposit to give sellers reassurance if they decide to take their home off the market. An earnest money deposit is separate from a down payment and is paid soon after the seller accepts an offer. It gives the seller some protection, in the form of compensation, if you decide to walk away without a valid and contractual reason. While an earnest money deposit isn't required to purchase a home, it's often seen in most real estate transactions.

This deposit can be applied towards closing costs or the down payment once the sale of the home is completed.

How much should you pay?

The amount paid is typically either a percentage of the purchase price or a fixed amount. It will usually range between 1-3% of the sale's price. This will vary based on the market you're in. For example, in a seller's market, you may be expected to offer more, whereas in a buyer's market you could potentially offer less - especially for a home needing improvements. When deciding on the amount, it can be beneficial to speak with your real estate agent directly. Whatever you decide, you want to make sure you're not putting yourself at risk financially.

If you're using gift money for your earnest money deposit, then speak with your lender about how that could affect your mortgage loan approval. In some circumstances, gift money could require additional paperwork for your lender and a verification of source of funds. 

Earnest money funds should never be paid directly to the seller. It's smart to place the money in a third party escrow account where it'll remain until closing. Acceptable payment methods include personal checks, certified checks or wire transfer.

Is it refundable?

There are agreed upon contingencies put into place that protect both the seller and buyer when earnest money is involved. These contingencies could include matters of financing, inspection, appraisals or more. The buyer and seller will sign a contract that defines the conditions of refunding any earnest money.

The seller could keep the deposit if the buyer fails to meet their contractual obligations. Make sure you're meeting any responsibilities and have a full understanding of signed contingencies, otherwise you could risk losing your deposit.

How does earnest money differ from due diligence?

If you reside in North Carolina, then you might have heard of the term "due diligence money". Due diligence money is due at the point of the acceptance of the contract. It is hard money that gets sent directly to the seller by overnight mail or wire transfer. It is not held in a third party escrow account like earnest money.

David Joyner, VP Mortgage Sales Manager of TowneBank Mortgage, says he typically sees anywhere from $1,000-$25,000, in due diligence but has heard of much higher. The amount of due diligence paid, like earnest money, can also vary due to the state of the market and price of the house. Multiple offer situations with clients not paying cash will typically amount to more due diligence fees being paid.

If the buyer terminates the contract or does not qualify for the loan, etc., then they will lose their due diligence. If they do close on the property, then the due diligence fee gets credited back to them as earnest money would. Due diligence is not refundable.

In conclusion

If you're in the market to buy, then you should consider how earnest money - or due diligence - could impact your home search and budget. Speak with your lender directly to learn more.
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