Earnest money

Earnest money is a term anyone who’s house hunting should understand. Bankrate explains it.

What is earnest money?

Earnest money, also called good faith deposit, is a sum of money that a buyer pays to the seller at the time of entering a contract. Its primary purpose is to make sure that the buyer is serious about following through on the contract. Typically used in real estate transactions, earnest money may be used to give the homebuyer more time while seeking financing. It provides the seller with incentive to continue with the transaction.

Deeper definition

Earnest money is not paid directly to the seller. The creation of an escrow account by a third-party broker helps ensure proper distribution of funds at the end of the deal.

Once a seller accepts an offer, the buyer is required to sign a contract known as the “purchase agreement.” This contract starts the earnest money process, which enters both the seller and buyer into a legally binding agreement for the purchase of the home at terms agreed upon.

Once the agreement is signed, the buyer is required to make an earnest money deposit to an escrow account held by the real estate agent or a title company. When all the provisions of the sale are satisfied, the money is paid to the seller as part of the purchase price.

However, if the buyer fails to find financing for the purchase, he can get his money back, provided that it is indicated in the contract.

Earnest money example

The amount of earnest money associated with a contract varies. The policies of the state where the agreement is made, the current real estate market, and the seller’s requirements help determine the amount. On average, buyers can expect to pay 1 percent to 2 percent of the total purchase price as earnest money.

In markets where homes do not sell quickly, the seller may require 1 percent or less in earnest money. But in markets where demand is high, the seller may require 2 percent to 3 percent.

Buyers have greater chances of winning a bid if they give the seller a large deposit. In fact, the seller may be willing to reduce the price if the buyer makes a larger deposit.

Use our calculator to determine how much house you can afford to buy.

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