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Earnest Money

Earnest money is a deposit or “good faith” payment that buyers of real estate must put forward in order to demonstrate their commitment to the purchase. It is usually between 1% and 10% of the sales price and is paid to the seller after acceptance of the purchase offer. Earnest money is not just a way of showing that the buyer is serious and diligently working toward the purchase; it is also a form of protection for both parties — the buyer and the seller.

In a real estate transaction, the earnest money is a critical component— after a contract is signed, earnest money is held in an escrow account. That money is released to the seller at the closing and is applied to the purchase price. There are generally two forms of earnest money: cash and a promissory note. Cash is the most straightforward form but a promissory note is sometimes used for bigger transactions and based on the buyer's creditworthiness.

Should a buyer decide to back out of the deal, their earnest money could be at risk of being forfeited, depending upon the terms outlined in the purchase agreement and applicable laws. Erroneously backing out of the contract, making unreasonable demands, or simply not having all the necessary paperwork ready on time can all result in loss of earnest money.

Thankfully, many deals are accompanied by contingency clauses that allow for the buyer to recover their deposit in the event something unexpected happens. Common options include receiving a return of full deposit amount, due to unforeseeable circumstances such as difficulty getting approved for a loan, failure of a home inspection, or other major issues identified prior to closing. The timing and conditions of a refund are always detailed in the purchase agreement.

In short, the earnest money deposit is an important, nonrefundable payment towards the purchase of a new home, and serves to protect both parties in the transaction. It shows the seller that they have a serious buyer, which makes their property more attractive to other potential buyers. It also serves as financial “insurance” for the buyer because it demonstrates their commitment to the purchase and may be forfeited if they fail to meet the terms of their agreement. Understanding the basics of earnest money is an important step for anyone looking to purchase a home, and can help ensure a smooth transaction from start to finish.

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