When conducting a real estate transaction, several steps required to finalize the sale. Therefore, once the offer on the property’s accepted, the next step would be to submit a deposit. An earnest money deposit or good faith deposit placed with a title company or seller’s broker. The deposit is important because it shows the buyer is serious about purchasing the property. Additionally, holding the buyer accountable to do the necessary things to close on the property. The amount of the deposit varies; however, it’s usually between 1 and 3% of the home’s purchase price.
What is a Good Faith Deposit or Earnest Money?
Good faith deposit, also known as “earnest money deposit,” is a term used in real estate that refers to a property buyer placing a deposit to show a serious level of interest. Once a signed agreement and good faith deposit placed with a third party, the property usually labeled “under contract” or “pending sale.”
The next step after submitting the deposit would be to schedule the inspections and appraisals. Essentially, the earnest money deposit allows for a clear understanding; meet all requirements to finalize the sale. However, it’s vital to note that if the buyer backs out for reasons not covered by contract contingencies, they forfeit the good faith deposit.
Purpose of a Good Faith Deposit
When making a deal, it’s always important to hold both parties accountable so that neither side wastes time and resources. A deposit gives the buyer a financial incentive to follow through with their offer on the property. Below is a more detailed explanation of the purpose and importance of a “good faith deposit.”
- Buyer’s commitment: Submitting a deposit that can be forfeited provides extra incentives to complete the deal. No one wants to waste money, and forcing an earnest money deposit (EMD) deters window shoppers or unreliable individuals.
- Reduces risk for sellers. Most homeowners have ongoing expenses, whether it’s paying a mortgage or just the annual taxes. Selling a property can be a multiple-month process, while the homeowner continues to pay expenses. Therefore, the last thing a seller wants, their time wasted and falling into a financial slump because of a faulty buyer.
- Essentially secures the property during the transaction. Although the sale’s not finalized until closing day. The property can be listed as “pending” or “under contract,” which means both sides are doing the necessary steps to close on the property. Adding more motivation to both parties, protecting the buyer during the inspection period.
Typically Earnest Money Deposit Required?
The standard good-faith deposit in real estate is between 1%-3% of the purchase price. Meaning if you’re buying a house for three hundred thousand dollars, your deposit will be somewhere between 3k to 9k, depending upon what both agents agree on. Certain factors that may influence the amount of the deposit: competitive markets, property price, sellers’ preferences, and the level of determination of the buyer. Additionally, the earnest money deposit’s held with the title company, the seller’s broker, or a real estate attorney.
Do You Get Your Good Faith Deposit Back?
Earnest money deposits are not always refundable. We list some reasons a good-faith deposit ends up returned to the home buyer.
- A buyer has their deposit returned if the home inspection is more severe than expected. Consisting of expensive repairs such as structural issues or the need to rewire the electrical system for the entire property.
- The home appraisal comes back much less than the purchase price, without the potential to lower the sales price.
- If the buyer cannot secure financing. Although, suggested that a buyer has pre-approved for a mortgage before the home search. Some buyers may wait, assuming their purchasing power, although at times the amount might be way less than what the buyer is looking at. At times, a lender or bank may not feel comfortable issuing the loan, which allows the buyer to back out, and the deposit gets returned.
- If the seller backs out of the deal, the buyer has their good faith deposit returned.
Buyers can lose their deposit for many reasons. Most reasons are due to failing to uphold their end of the deal. If a buyer waives contingencies such as inspections, they cannot back out if the damage is more extensive than originally assumed. Additional reasons why buyers lose their earnest money deposit are missing deadlines or simply changing their minds for non-protected reasons, such as finding a different home.
Contingencies that Protect Earnest Money Deposit
- Inspections: Once the inspections completed, both the seller and buyer become aware of the property’s defects and necessary repairs. At this point, the buyer can renegotiate the sales price. Therefore, if the seller’s not willing to work with the buyer on the sales price or give credit towards repairs. The buyer then can back out, and their good faith deposit ends up protected and returned.
- Financing: When a homebuyer uses a mortgage company, bank, or lender, it’s up to those financing the deal to approve everything. If the lender doesn’t feel comfortable issuing the loan amount, the buyer has the right to back out, and the deposit’s refunded.
- Appraisal: If the buyer doesn’t waive inspections and appraisals, they have the right to back out of the deal if the home appraisal comes back much less than the sales price. Additionally, the deposit gets returned to the buyer if both sides aren’t able to agree on a new sales price.
Mistakes to Avoid with Good Faith Deposit
The most important thing a buyer can do during a real estate transaction is to protect themselves. Therefore, buyers should avoid these common mistakes to protect their earnest money deposit:
- Missing deadlines: In order to fully complete a real estate sale, each step has to be done within a reasonable time frame. On average, a home inspection needs to be conducted within 7 to 14 days after the seller accepts the buyer’s offer.
- Removing contingencies way too soon. When buying a home, the appraisal and inspection are vital factors to protect a buyer from overpaying or purchasing a home that requires tons of work. Try not to waive the contingencies; allow the inspector and appraiser to do their jobs. If anything, the inspection and appraisal can be used as a bargaining chip to lower the sales price or to receive credit towards repairs or even your down payment.
- Failure to properly document everything in writing. Verbal agreements are typically not enforceable in real estate. Everything needs to be in writing and documented utilizing a real estate agent. One simple mistake within the contract can cost the buyer their good faith deposit.
- A common mistake involving an earnest money deposit is not fully understanding the terms and circumstances of the deposit. It’s vital to know that the good-faith deposit is not always refundable. In addition, complete the proper steps to receive the deposit back if things don’t go as planned.
Knowledge is Key: Involving Earnest Money Deposits
Earnest money deposits, commonly referred to as a good-faith deposit, are a crucial part of a real estate transaction. It’s the next step following the agreement of sale, showing the seller that the buyer is serious about purchasing the property. Allow the real estate agent or professional to guide the transaction. A realtor knows how to protect a buyer’s deposit. In addition to the ins and outs of renegotiating the sales price, if defects are exposed during the inspection period.
Additionally, as a buyer, ensure you don’t miss any deadlines while fully understanding the contract terms. A good faith deposit in real estate can be returned if the buyer upholds their part of the deal or if things fall through at no fault of their own. Therefore, follow the advice of your licensed agent to ensure a successful real estate sale!