Your Mortgage: Earnest money – what is it?

Put simply, earnest money is money paid to confirm a contract. In the lending industry, earnest money is part of nearly every single real estate purchase contract. Earnest money tells a seller that a buyer is serious, while also preventing buyers from making offers on several homes at once and taking them each off the market to other potential buyers. Earnest money stays with the transaction and is applied towards the funds required to close. It can also be refunded if either no additional funds are required to close or if something goes wrong with the transaction.

Typically, an earnest money deposit averages about 1-2 percent of the agreed upon sales price. It’s written by either the real estate broker or a title company involved on the sale side of the transaction and generally deposited within the first week or two into an escrow account to be released on the day of closing.

Here are some common questions I hear regarding earnest money:

Consider a purchase price of $225,000 with a buyer putting five percent down at closing which is equal to $11,250. This is the amount that is owed the day of closing to complete the transaction. If earnest money was part of the contract equal to one percent, the buyer would be bringing $9,000 to closing ($11,250 – $2,250 = $9,000).

This could happen resulting from a couple different situations. First, if a buyer financed 100 percent of the price with either a VA loan, USDA loan or a down payment assistance program, the loan amount would be equal to the price. The earnest money would have nowhere to be applied to and thus be returned to the buyer at closing. Secondly, things periodically happen like a home not passing inspections or a buyer being denied a home loan. Technically, contract language exists which may allow a buyer to be refunded a portion or entire amount of the earnest money even if they are denied a loan. This should hardly ever happen, however, because the financing bank should have done a pre-approval before the transaction started.

The short answer is yes. If earnest money is part of a purchase contract, it has to be documented. It might sound less than exciting to read about documenting earnest money, but I personally find it to be one of the most frequently asked questions from buyers. It warrants a dedicated post to help line up expectations, and it’s never too early to get prepared.

This weekly Sponsored Column is written by Fountain Mortgage. Located in Prairie Village, Fountain Mortgage is dedicated to educating, and thus empowering, clients to make the best financial decision possible for their situation. Contact Fountain today.

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