What is Earnest Money?
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This is a question I get from a lot of first time home buyers: “What is the Earnest Money and what does it pay for?”
The Earnest Money is usually a check or cashier’s check that gets written from the buyer to a seller at the time an offer is made. The check actually gets made out to the listing broker (i.e. Re/Max Advantage Plus) and NOT the homeowner or REALTOR®. It then gets deposited into the listing broker’s trust account, which is a bank account held by the broker. And there the check sits, and waits until closing.
At the time of closing, the buyer will usually see this money returned to them on the HUD statement, which breaks down all the fees and payments for both sides of the sale.
Think of it like a security or damage deposit on an apartment. You pay the fee at the beginning as a “just in case” backup. This way, if you decide to back out of the deal for an undisclosed reason, then the seller will get to keep that money as damages. If you stick to your contract to buy the home, the money is returned to you as a credit, and will go towards your closing costs or mortgage origination fees.
There are times when you can back out of a contract and still retain your Earnest Money. This is where contingencies come into play. The most common contingencies are the Inspection Contingency, and the Financing Contingency. If you write up an Inspection Contingency, you have the right to inspect the property, and if something is discovered with the inspection that you don’t like, you can back out of the deal and get your money back. If you write up a Financing Contingency, you can back out of the deal if you are not able to obtain the loan to buy the property.
(Note: if you’re buying your first home and aren’t familiar with common problem areas in houses, I strongly suggest the home inspection)
Regardless of your contingencies, you should be aware that your Earnest Money check will be cashed if the offer is accepted by the seller. So make sure you have enough money in your bank account so the check doesn’t bounce!
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Comments
Great info! I once had a client describe it at as a ‘lay-a-way’ type program like the ones you see in department stores. I laughed so hard, because it is somewhat true! You put a bit down in the beginning to secure the item and can take possesion when you pay the rest, usually with the mortgage at closing!
It can often times be confusing for first time buyers when discussing what earnest money really is. Thanks for this great post Steve!