If you are planning on buying a home, there are some up front, out of pocket expenses you will want to be prepared for. These funds should be liquid and easily accessible whether you are financing or paying cash. The three main checks you will be writing (who writes checks anymore?) are for the home inspection(s), the home appraisal (required if you are financing, not required if you are paying cash), and earnest money. But what is earnest money and why do you need it?
If you have been a renter, you are familiar with a security deposit. It is money that you put down upon signing a lease that “secures” your rental property, and can be used in the event that there are unpaid expenses at the end of your lease agreement. Earnest money is similar, and not so much. Earnest money is paid at the time that a purchase agreement is signed, sealed and delivered. It usually amounts to 1 – 2% of the purchase price and it’s main function is to prove that you are serious in your intent to purchase the property, that you are financially able to access funds necessary to close the sale, and sometimes, can be increased to make your offer more appealing when there is a lot of competition for a particular property.
Earnest money is almost always deposited into a neutral “escrow account” held by a title company that administers the terms of the contract and disburses all funds per those terms. That money IS deposited so understand that although the seller will not have access to those funds until closing, the check or wire WILL clear. Can you ever get that earnest money back? Good question. And the answer is, it depends upon how the contract is written.
A good buyers agent will ensure that there are contingencies written into the contract that will allow the buyer to get the earnest money back if those contingencies are not met. For instance, if there is an inspection contingency, then the buyer will have a period of time agreed to by all parties within which to inspect the premises and the neighborhood and by the end of that period, either accept or reject the property. In the event the buyer rejects the property, all earnest money will be refunded to the buyer. Another typical contingency concerns an appraisal. Particularly in a financed purchase, the lender will require that the property be appraised. If the value does not come in as high as the purchase price, the buyer will have the option to cancel the contract and have their earnest money refunded (within a certain period of time defined in the contract terms). A third common contingency is the unfulfilled loan contingency. Within a certain amount of time prior to completion of the sale, if, through no fault of the buyer, they cannot qualify for financing, then the buyer can cancel the sale with appropriate documentation, and get their earnest money returned.
Keep in mind that if the buyer is in breach of the contract terms, they may not get their earnest money refunded. If the buyer cannot perform due to their negligence, the seller has wasted a chunk of time with the home off the market and must go back to square one. The earnest money can provide some consolation to the seller. A buyers agents job is to protect the earnest money for the buyer and to make sure all terms are complied with so that if the deal falls apart, the buyer can be made whole again. And the good news? Earnest money is typically applied toward the downpayment and closing costs at the close of the transaction.