When you're in the real estate market for a new property, you're required to make a lump sum payment for the transaction. However, if you don't have the funds readily available, you can make an earnest money deposit to demonstrate your intent to purchase the property.
Also known as a good faith deposit, it shows commitment from the buyer to the seller to purchase the property. This initial deposit allows you extra time to conduct a title search, property appraisal, and arrange financing before finalising the property deal.
This article will help you understand earnest money's meaning and importance in real estate.
Earnest money definition
Earnest money is a small deposit the buyer makes to the seller, representing a buyer's good faith and intention to buy the property. This deposit is commonly made in high-value real estate transactions such as purchasing a new home, a commercial property, or investing in a project.
The amount of earnest money can vary depending on the property, but it is typically a small percentage of the price of the concerned property. Once deposited, these funds are held in an escrow account until the sale is finalised, at which time it goes towards the purchase cost of the property. Alternatively, if the sale is not completed, this amount is returned to the buyer in most cases.
How does earnest money work?
The buyer usually makes an earnest deposit while making an offer on the property. Once the seller accepts the offer from the buyer, they enter into a contract or purchase agreement. This contract lays down the terms and process of the deposit transfer to the seller and is legally binding on both parties.
The contract also includes the terms of earnest money refund as agreed upon by the parties. As the contract is legally binding on the buyer, they may lose the earnest deposit if they break the contract terms. That said, it is not the buyer's obligation to purchase the property; it merely demonstrates an intent to purchase the property, and the buyer can reclaim the earnest deposit if anything goes wrong.
Importance of earnest money deposit
1. Show of good faith: Earnest money deposit assures the seller of the buyer's commitment and seriousness to purchase the property.
2. Increases credibility of the offer: The property might be in high demand with the seller receiving multiple offers. In such a competitive market, making a sizeable deposit can make a buyer's offer stand out. It can also help them better negotiate the contract terms.
3. Offers a buffer period: Paying earnest money to the seller gives the buyer more time to arrange for the purchase amount and conduct appraisals, inspections, and other due diligence before finalising the property.
4. Held securely in an escrow account: Escrow refers to an account set up and managed by a lender to hold funds for property-related transactions. The buyer and seller often create an escrow account with a neutral third-party broker to deposit the earnest money till the sale is finalised. This ensures a fair transaction and the security of the funds.
5. Part of the purchase cost: Once the property sale is completed, the earnest deposit is considered a part of the total purchase cost.
Conditions for earnest money refunds
In most cases, an earnest money deposit is refundable if both the buyer and seller fulfil the conditions mentioned in the contract. Here are the specific conditions under which buyers can get their earnest deposit back-
1. Suppose a home inspection reveals any issues with the property. In this case, the buyer can negotiate the responsibility for repairs or back out of the deal.
2. If the buyer is unable to secure the funds required for the purchase (as long as this contingency is agreed upon).
3. If the home appraisal results in a lower value than the agreed purchase price. The buyer can negotiate the price or pull out of the deal.
4. If the buyer is unable to sell their existing property ((as long as this contingency is agreed upon).
How do you protect earnest money?
A prospective buyer can take several steps to protect their earnest money deposit-
1. Get the contract terms in writing
The earnest money contract between the buyer and the seller should be in writing. This helps set the precedence for the terms of the agreement and eliminates the possibility of disputes. While amendments to the contract are allowed, the parties must ensure that every change is agreed upon and signed.
2. Ensure the contract includes contingencies for financing and inspections
In certain cases, the buyer might decide to back out from the purchase agreement due to the unavailability of finance or any issues during the inspection. However, doing so will lead to forfeiture of the deposit amount. As a result, contingencies for financing and inspection should ideally be included in the contract.
3. Understand and comply with the contract terms
Make sure to read the contract thoroughly and understand each term and condition. This will help eliminate any misunderstanding. In addition, not following the terms can lead to the buyer losing the deposit amount. So, it is important to adhere to the terms mentioned in the contract.
4. Use an escrow account to deposit the funds
Instead of sending the earnest money deposit directly to the seller, it is ideal to use a third-party escrow account to keep the funds safe and ensure honest transactions.
5. Verify the third-party
It is also equally important to verify the credibility of the third party holding the escrow account. The deposit should be made to a reputable third party, such as a legal firm, escrow company, or a well-known real estate brokerage. Further, buyers must also insist on a receipt for the deposit.
In the end
Earnest money deposit is a useful facility that helps buyers make high-value real estate transactions and offers the sellers assurance of the transaction. Moreover, when entering into an earnest deposit contract, make sure to read the contract carefully and abide by the terms to protect the funds.
And if you're looking to buy a new home, get in touch with Tata Capital for a home loan. Our range of home loans is tailored to meet your needs, with attractive interest rates, flexible repayment terms, and a simple application process.
Contact us today!
08 December 2023
6 mins read
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