Real Estate Q&A
We are getting ready to start looking for a new home. We are trying to get our finances in order and saving up our down payment for our first home. So far, we have mostly been looking at homes online. We have found several homes that we are interested in looking at, but are a little confused about the earnest money. Our anticipated price point is in the neighborhood of $200,000 and see that the earnest money varies from home to home. Some homes require as little as $500 and some homes are as much as $5,000. All the homes are in a similar price range, why is the earnest money so different? What is the earnest money for? How does it work? When we put down the earnest money, is it gone when we have an offer accepted? If you could explain earnest money, it would be greatly appreciated.
Thanks for your help.— Randy and Jill, Grand Junction
Randy and Jill,
This is a great question. There are many buyers and sellers that really do not understand earnest money. First, let me say that it sounds like you are going about this the right way. Getting your fiscal house in order and saving for your down payment is a very responsible way to plan for your first home. By having your finances in order, you will set yourself up for success with home ownership.
Earnest money is an amount of money given to a seller by a buyer that demonstrates the buyers “good faith” to follow through with the purchase of the property. After all, you are requesting the seller to take their home off the market while you pursue the purchase. Earnest money will also, generally, demonstrate to the seller the strength of the buyer from a fiscal perspective. For example, if the home you are making the offer on is requesting $4,000 of earnest money and you offer $1,000 in earnest money then the seller will typically interpret that you do not have much money in reserve and may also assume, right or wrong, that your financial ability may be in question. However, if you offer $6,000 in earnest money, the same seller will interpret that you potentially have stronger financial ability and you “really want the home.” Every home seller loves to accept offers from buyers who “really want” their home. I have seen multiple offer situations come down to earnest money. All things being equal, the offer with the highest earnest money typically wins. Here is a free tip, if you find yourself in a multiple offer situation, offer more earnest money than they are asking for and you may find that small move is all the advantage you need. Most people want to put down as little earnest money as possible and sellers generally do not look favorably on low earnest money.
The amount of earnest money requested is typically arbitrary, meaning there may be no real rhyme or reason to the amount requested. When I make a recommendation on the amount of earnest money to ask for, I say it should be enough to demonstrate good financial ability, but substantial enough that the buyer wouldn’t want to lose it. It is intended to lead us to a buyer who can complete the purchase and does not want to lose their earnest money and will work in “good faith” to see the contract through to close. Please keep in mind, in the state of Colorado, we have very buyer friendly contracts. When you put in your offer, your real estate agent will go over the contract in full and there will be a date table that will outline many dates and deadlines you will follow through the contract phase of your purchase. If you opt out of your contract and are in compliance with your dates and deadlines table then you will NOT lose your earnest money, whether your earnest money is $2,000 or $20,000. For instance, if you progress through your contract and find at your loan conditions deadline that your loan falls through, as long as you notify the seller on or prior to the date set forth in your contract, you will receive your earnest money back. You risk the loss of your earnest money when you miss dates and deadlines set forth on your contract to purchase. Remember, once you have a contract that has been accepted you are part of a binding contract and should take the contract and the ramifications of not following the contract very seriously. As you can imagine, as the amount of earnest money goes up, it helps ensure the contract is taken seriously by all parties.
Earnest money is not intended to lock you into a purchase that for some reason can not be completed for cause, but is intended to show good faith of your intentions and compensates the seller for expenses incurred and lost marketing time, should the contract fall apart after ALL the dates and deadlines have past. Earnest money also protects, at least monetarily to some extent, the seller from a buyer who does not properly adhere to an executed contract.
How much earnest money is requested is a topic that is often debated in my business, but I hope this helps add some clarity for you as you pursue your new home.
The Kimbrough Team
RE/MAX 4000, Inc