The Value of Earnest Money
Earnest money is not a complicated topic, but it is one of the most important parts of the transaction for both buyers and sellers. This article will mostly be written from the buyer’s perspective.
Earnest money: the initial deposit that a buyer makes when they go under contract. This is protected money, meaning it goes towards their down payment on closing day, and as long as they don’t breach the contract it gets returned to them if the deal doesn’t work out. I’ll talk more about this later.
For sellers, earnest money is assurance that the buyer is sincerely interested in purchasing the home and not wasting the seller’s time. In the event that the buyer breaches the contract, earnest money is the payment they’ll receive for compensation.
First, how much is earnest money? This is a negotiable point, but in most cases I see earnest money at about 1% of the purchase price. For example, a home with a $500,000 purchase price will likely have an earnest money deposit of $5,000. I’ve had buyers put down as much as 10% when they’re really crazy about the home.
As I’m about to talk about, there are a handful of deadlines in the contract that protect the earnest money for the buyer based on different aspects of a real estate deal. Occasionally, a buyer will offer to make some or all of their earnest money deposit “hard” (non-refundable) from the start in order to be the strongest offer in a competitive situation. This means that if the deal doesn’t work out for any reason, the earnest money goes to the seller. However, when the deal closes, the money is still credited back to the buyer and used toward the down payment. For most deals involving new construction, earnest money goes hard immediately and is not refundable for any reason. Be sure to ask your agent to make this clear to you!
Let’s talk briefly about the dates and deadlines I usually see for residential homes in the Denver market. I know that other markets have different deadline structures, so be sure to check with your agent about that. We are going to assume an approximately 30-day closing for these deadlines. If it’s a shorter or longer close, some of these may be adjusted:
Disclosures are a standard part of the process and sellers usually only have a few days to submit those to the buyer. If the buyer doesn’t receive them, they can terminate the contract and receive their earnest money back.
The most important ones to look at are the property deadlines, especially inspection deadlines. By these deadlines, especially the inspection termination deadline, a buyer can cancel the contract for nearly any reason and get their entire earnest money deposit back, assuming no other arrangement was negotiated. The contract states that it may be terminated for ANY UNSATISFACTORY condition.
During the inspection period, a title company is usually pulling the title and looking for any easements, liens, etc. and during this time must also disclose any issues that may not be public record. Again, there are deadlines in the contract that allow the buyer to back out and receive their earnest money back if any of the information is deemed unsatisfactory.
Association Deadlines are for any property that has an HOA component. The seller typically has about a week to deliver these and the buyer has about 3-5 days to review and accept them or object and receive their earnest money back.
Surveys don’t happen a lot in urban areas, but are more common for ranches and horse properties. However, any buyer has the option of making it part of the contract, and the deadline to complete that and accept the results is usually 2-3 weeks.
An appraisal will happen any time the buyer is getting a loan, but any buyer can require an independent appraisal if they choose. If the appraisal comes in below the agreed purchase price it could set off a round of negotiations, or if the buyer chooses they can terminate the contract and receive their earnest money back.
Finally, the loan date. This is usually 5-7 days before closing. By this date the buyer needs to accept all parts of their loan. This is usually the last stop that protects the earnest money. The acceptability of the loan is entirely up to the buyer; the seller has no say.
Boy it sure looks like the buyer and their earnest money deposit are protected a lot along the way! Well, it’s true. Buyers are well protected if the contract is written correctly by their agent. When working with the seller I try to negotiate to tighten up those contracts as much as possible so they are protected also.
You might find it interesting that at the time of writing this, I have never been part of a deal where earnest money was surrendered from the buyer to the seller! Sometimes contracts don’t make it to close, but because of the way the Colorado approved contracts are written, the earnest money is usually returned. Buyers, make sure you are working with someone who prioritizes protecting your earnest money! This means someone who will stay organized and keep you abiding the dates in your contract.