What is Earnest Money & How does it Work?

what is earnest money

If you are buying a house, you need to know what earnest money is and how it can benefit you. It is typically used when you are buying or selling a house, and there is a lot of competition. In such a case, Earnest money will help you close the deal in your favor.

But what exactly is this Money and How does it work?

What is Earnest Money?

Earnest Money or Good Faith Deposit is the deposit you make to assure the seller that you are interested or having good faith in buying the house.

Consider it as prepaid money that assures the seller you are interested in buying the house, but this money is not paid to the seller. Instead, this prepaid money is paid to deposited in a third-party account such as an Escrow account that ensures none of the parties are cheated.

An escrow account keeps the money safe while both parties are doing the procedures of buying or selling. If the buyer backs out after the contingency period, the prepaid amount is given to the seller. Moreover, if there are legal issues or if the buyer legally backs out during the contingency period, the money is refunded to the buyer.

This prepaid deposit is only given against the contract and depends upon the total cost of buying the house. Suppose you are buying a house for $15000, you may have to deposit around $4000 as Earnest money roughly. Although, it varies and depends on the amount you are paying. In such a case, a legal system can help you in making this decision.

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Why Earnest Money?

It is an easy way to convince the seller when there is a lot of competition for the house. Suppose you are bidding for a house and another person makes the same deal. The seller will be confused about whom to sell the house to. In such a case, when you make an offer with some amount of money, you stand out from the competition. Additionally, it convinces or assures the seller that you will buy the house as you have paid the upfront cost.

Moreover, these are huge contracts that require several people behind them to work. There is a team from the legal department, from the inspection, bank employees, and more. To make the deal more genuine and assure the seller the earnest money is a viable option and best practice.

But you cannot find earnest money in all the places in and around; it is traditional and outdated. But it works perfectly fine. Also, it involves risk as there is a good chance of losing your money if you are a buyer.

I want to clear a doubt about Earnest money; it is not an additional cost.

A lot of people confuse it as an additional cost and think of it as paying more. Whereas it only a prepaid deposit against the final cost. Let me be more clear to you; if you are paying $4000 as earnest money and the final cost is $12000, you are paying anything more at the end. You only owe $8000 to the seller as you have already prepaid the money. Consider it as an early downpayment.

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What is Contingency Period?

The contingency period is when the buyer needs to complete the legal procedures such as inspection. The contingency period is 15 days, and on the 1st day, the seller hands over the house to the buyer. Now, the buyer needs to perform an inspection, approve the bank loan(if any), and do other legal procedures.

If the buyer is not satisfied, he can legally back out from buying the house, and the earnest money is refunded. This also involves if the buyer finds any legal issues or doesn’t get the bank loan approved. On the other hand, after 15 days, if the buyer backs out from buying the house, there is no way for him to keep the money; in that case, the money is given to the seller.

The Earnest money method is a bit of fuss. When the buyer backs out after the contingency period, the seller is given the money; but both parties agree upon it or arbitrate the decision. This can cause a bit of mess and is also one reason why earnest money is outdated.

If the Earnest Money in Escrow account crosses the interest money of $600, the buyer needs to pay tax and file the tax form-w9 as per US laws.

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Frequently Asked Questions

What is Earnest Money in a contract?

Earnest money or good faith deposit is the money you deposit to show good faith or interest to buy the house. This money is deposited to a third-party account such as an Escrow account and assures the seller you are genuinely interested in buying the house.

Can seller keep your Earnest Money?

If you are backing out for no reason or back out after the contingency period, the seller gets to keep the money.

What if the bank loan you applied is fail, will you get the earnest money?

If the bank loan or financing fails, you get to keep your earnest money during the contingency. Moreover, if the bank loan fails after the contingency, there is no possible way to get your money back.

Backing out at inspection, will you get your money back?

If you are backing out at inspection, it should be during the contingency period; Only then will you be given your earnest money back. After the contingency period, you cannot get a refund.

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