Does Earnest Money Go Towards Closing Costs?
Yes, it does in all 50 states.
Trying to purchase a home is both exciting and costly. As a home buyer, you need to consider all the fees and expenses before making a final decision. One of those costs is the earnest money deposit.
Because this deposit is crucial for the homebuying process, we are going to dive straight into how it works.
Is Earnest Money Part of Closing Costs?
Yes. Buyers will pay earnest money before signing the home purchase agreement. Then, at closing, these funds can go toward the home's down payment and closing costs.
Earnest money is different from a homebuyer's down payment, even if the amount is similar.
What is an Earnest Money Deposit?
Earnest money deposits provide confidence to the seller to take the home off the market and guarantee exclusivity of the sale to one selected buyer. And it gives the buyer time to get home inspections to ensure the house is buy-worthy and to secure their loan.
Since buyers and sellers have a lot on the line during the home buying process, they both need assurances that the real estate transaction will go through. Earnest money provides that assurance.
Buyers pay earnest money when signing a purchase contract, and their lawyer puts the funds into an escrow account until both the buyer and seller meet the terms of the purchase agreement. These funds act as a good faith deposit to show the seller that the buyer is serious. Without this money, sellers may not want to work with a buyer.
What is a Due Diligence Period?
Buyers must do their due diligence before closing on a property. During this due diligence period, buyers do the following:
- Examine the seller's disclosure statement
- Check homeowners associations (HOA) rules (if applicable)
- Obtain a home inspection
- Calculate repairs
- Check utility costs
- Secure their mortgage loan
- Drive around the home's neighborhood and talk to neighbors to learn about the neighborhood
- Survey the property
- Get a property appraisal
- Conduct a title search
- Buy home insurance
Without due diligence, there could be some nasty surprises waiting once the buyer moves in. Once the deal closes, any issues are the buyer's responsibility, so this period is crucial.
What is Non-Refundable Earnest Money?
As the name suggests, non-refundable earnest money deposits do not go back to the buyer.
Usually, this happens with new construction homes because there is a greater risk involved for the builder.
Typically, the purchase agreement allows the earnest money to be refundable for existing homes if the deal falls through and both parties meet the purchase agreement terms.
Is Earnest Money Required?
No, buyers do not need to provide earnest money to enter a purchase agreement. However, in a hot real estate market, earnest money deposits are often required. In most cases, sellers will not accept an offer without an earnest money deposit.
No law mandates earnest money, it is a real estate standard set in each state, and the protocols vary by state.
How Much Earnest Money is Required?
The amount depends on several factors. New construction homes will typically require five to 10 percent of the sale price. Otherwise, the amount is often one to three percent.
Again, the type of market can also dictate the size of the deposit. For example, hotter markets will need more money because of extra competition.
Who Pays Earnest Money?
The buyer pays earnest money to show the seller that they are serious.
How to Pay Earnest Money
Each state has strict rules regarding how buyers pay earnest money. Buyers typically provide a certified check or wire money to a title company, the buyer's attorney, or their real estate agent.
The party that receives the earnest money then becomes the escrow agent. The money stays in escrow until closing or until the deal falls through (if applicable).
Who Opens Escrow - The Buyer or Seller?
Usually, the buyer opens escrow by working with a third-party representative, like a real estate broker or agent.
Which Party Holds the Escrow When a Dispute Occurs?
Whoever opened the escrow account holds it when a dispute happens. An escrow agent can stay objective until the parties resolve these issues.
What Happens if a Homebuyer Does Not Deposit the Earnest Money?
If the buyer does not deposit the money, they are in breach of contract. When that happens, the seller can break the deal or renegotiate for a higher sum. The exact circumstances should be part of the purchase contract.
Proof of Earnest Money Deposit
When the buyer pays the deposit to a third-party representative, they will receive a receipt. This receipt acts as proof of earnest money deposit. Without this proof, the seller may try to back out of the deal.
What if I Don't Have Earnest Money?
Buying a house is an expensive proposition, so you should be ready with earnest money. If you do not have that kind of cash on hand, it will be much harder to close on a new home. Again, laws do not dictate this deposit, but it will help you stand out in a competitive market, and sellers often require it regardless.
What Does Earnest Money Go Toward?
Since these funds stay in escrow until closing, they can go toward two things: closing costs or the down payment.
Does Earnest Money Go Toward the Down Payment?
It can if that is what the purchase agreement says. Otherwise, the funds can go toward the closing costs.
Buyers do not pay earnest money as extra costs in addition to closing costs. Therefore, it will go towards either closing costs or the down payment.
Do You Get Earnest Money Back?
If you close the deal, you do not get your deposit refunded. However, there are some instances where the home purchase deal may fall through, and in those instances, the buyer can get the money back if the home purchase contract lists the contingencies, such as:
- Home Inspection Issues. If a home inspection turns up something serious, the buyer can back out and receive their deposit — for example, a cracked foundation.
- Property Appraisal Issues. Sometimes, the property may not be worth the purchase price. In this case, the buyer can renegotiate the terms of the deal or get their money refunded.
- Home Financing Issues. Buyers should get pre-approved for a mortgage loan before making an offer. However, they can still get denied by the lender.
- Unreasonable Homeowners Association (HOA) rules (if applicable). If the seller did not disclose unreasonable costs or limitations upfront to the buyer, the buyer might want to cancel the deal.
For example, the HOA may require an $85,000 yearly HOA fee for club membership (common in Florida) or an ongoing condo assessment the new buyer must pay on top of the condo monthly maintenance fee.
Assessments are monies paid for items like building upgrades (a new plumbing system) and can cost the buyer hundreds to thousands of dollars monthly.
- Inspect the Neighborhood. What if you find out there is a children's park near the home where drug dealers commonly sell drugs, and the seller did not disclose it? Crime and risks increase, and you may wish to back out.
Or, what if there is a pending government easement planned for your property, like a utility line or shortcut walkway people use to get to a swimming hole or bus stop. Do you want random people traversing your property?
- Property Survey Issues. The home may be in a flood zone, and the seller could have withheld that information.
- Title Issues. The seller may have had construction done and not paid for it, and the contractor put a lien on the house or condo to recoup their money. You must pay that money to the contractor via closing costs during the homebuying process.
Or inheritance issues may arise whereby another owner has title to the property.
- Home Insurance Denials. If the seller filed numerous claims in the past, home insurance companies might deny you home insurance because they deem the property too risky.
These contingencies should be part of the purchase contract, so make sure that you read it thoroughly. You can also talk to your real estate attorney or real estate agent about any specific questions you may have.
In all cases, the homebuyer and seller must sign off on the escrowed earnest money release.
Do You Get Earnest Money Back at the Closing?
No, the funds go toward closing costs or the down payment. The only time a buyer gets earnest money back is if the deal falls through for reasons allowed in the purchase contract.
Who Gets the Earnest Money?
The seller can and will keep the earnest money if the deal goes through. Also, if the buyer violates the contract, the seller receives the funds.
Who Gets the Earnest Money After Closing?
If the money goes toward the down payment, the lender gets it. But, on the other hand, if earnest money goes toward closing costs, it will spread between different entities, such as the real estate agents, title companies, etc.
Who Gets the Earnest Money if the Deal Falls Through?
If the home purchase deal falls through because of an allowed contingency, the escrow agent returns the money to the buyer. If the deal falls through for a non-allowable reason, it goes to the seller.
What Happens to Earnest Money if the Seller Pays the Closing Costs?
In that case, the homebuyer's earnest money will go toward the down payment.
When Can the Seller Keep the Earnest Money?
Sellers can keep earnest money deposits if the buyer backs out for a non-allowed reason. Buyers can only back out for allowed reasons listed in the purchase agreement.
For example, if the buyer finds a better house and cancels the deal, usually the buyer cannot back out and get their earnest money back.
Earnest Money Timeline
A lot happens between making an offer on a home and closing. The exact deadlines for each of these elements depend on the contract. Here is a quick rough rundown of the home buying timeline:
- The buyer pays the earnest money into escrow, and both parties sign the purchase agreement
- Buyer proceeds with their due diligence (see a complete list above)
- Escrow funds released at closing
When is Earnest Money Due?
Usually, the deposit is due when the buyer signs the purchase contract.
When is the Earnest Money Check Cashed?
The short answer is "immediately." The title company will want to make sure that your check clears before moving forward with the deal. Often, buyers must use a certified check for earnest money deposits, not a personal check. Wires also are standard.
Releasing Earnest Money Prior to Closing
In most cases, it is a bad idea to release earnest money before closing. Doing this puts an additional risk on the buyer since you will not get it back once the seller gets the money. So please do not do it, even in a hot market.
Get Home Insurance for Your New House
If you are about to purchase a house, you will need home insurance. But do not wait until the last minute to get a policy. Let us help you find the best co-op, condo, or home insurance coverage for your needs.
Hope that helps!
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