Earnest money is a deposit made to a seller that represents a buyer’s good faith to buy a home. The money gives the buyer extra time to get financing and conduct the title search, property appraisal, and inspections before closing.
In many ways, it can be considered a deposit on a home, an escrow deposit, or good faith money.
When Is Earnest Money Required?
In most cases, the earnest money is delivered when the sales contract or purchase agreement is signed. But it can also be attached to the offer. Once deposited, the funds are typically held in an escrow account until closing. At which time the deposit is applied to the buyer’s down payment and closing costs.
When a buyer decides to purchase a home from a seller, both parties enter into a contract. The contract doesn’t obligate the buyer to purchase the home. This is because reports from the home appraisal and inspection may later reveal problems with the house. The contract does, however, ensure the seller takes the house off the market while it’s inspected and appraised.
To prove the buyer’s offer to purchase the property is made in good faith, the buyer makes an earnest money deposit (EMD).
Can A Buyer Ask For The Money Back?
The buyer might be able to reclaim the earnest money deposit if something that was specified ahead of time in the contract goes wrong. For instance, the money would be returned if the house doesn’t appraise for the sales price or the inspection reveals a serious defect—provided these contingencies are listed in the contract.
However, it isn’t always refundable. For example, the seller gets to keep the earnest money if the buyer decides not to go through with the home purchase for contingencies not listed in the contract. Or if the buyer fails to meet the timeline outlined in the contract. The buyer will, of course, forfeit the earnest money deposit if they simply have a change of heart and decides not to buy.
Earnest money is always returned to the buyer if the seller terminates the deal.
Related: Can a Seller Keep a Buyer’s Earnest Money Deposit?
Can The Buyer Choose The Earnest Money Amount?
While the buyer and seller can negotiate the earnest money deposit. It often ranges between 1% and 2% of the home’s purchase price, depending on the market. In hot housing markets, the money might range between 5% and 10% of a property’s sale price.
While the earnest money deposit is often a percentage of the sales price, some sellers prefer a fixed amount. Of course, the higher the earnest money amount, the more serious the buyer. Therefore, a buyer should offer a high enough earnest deposit to be accepted. But, not one so high as to put extra money at risk.
Earnest money is usually paid by certified check, personal check, or a wire transfer into a trust or escrow account that is held by a real estate brokerage, legal firm, or title company. The funds are held in the account until closing when they are applied toward the buyer’s down payment and closing costs.
It’s important to note that escrow accounts, like any other bank account, can earn interest.
Protecting Your Earnest Money Deposit
Prospective buyers can do several things to protect their earnest money deposits.
- Make sure contingencies for financing and inspections are included in the contract. Without these, the deposit could be forfeited if the buyer can’t get financing or a serious defect is found during the inspection.
- Read, understand, and abide by the terms of the contract. For example, if the sales agreement states the home inspection must be completed by a certain date, the buyer must meet that deadline or risk losing the deposit—and the house.
- Make sure the deposit is handled appropriately. The deposit should be payable to a reputable third party, such as a well-known real estate brokerage, escrow company, title company, or legal firm (never give the deposit directly to the seller). Buyers should verify the funds will be held in an escrow account and always obtain a receipt.
Example of Earnest Money
Suppose Alice wants to buy a home worth Kes 10,000,000 from Mary. To facilitate the transaction, the agent arranges to deposit Kes 100,000 as a deposit in an escrow account. The terms of the subsequent agreement signed by both parties state that Mary, who is currently living in the home, will move out of it within the next six months.
But she is unable to find another place of residence by moving day. As a result, John cancels the transaction and gets his deposit money back. The deposit money has earned interest of Kes 50,000 from the escrow account during this time period. Since the amount is less than Kes 50,000, John is not required to fill out a form to retrieve the amount.
Note: Most Kenyan homebuyers use the seller’s real estate company as an escrow company while making payments. Although, the buyer can sometimes make payments directly to the seller.