When you buy a home, there is more to think about than just the curb appeal and neighborhood. Earnest money is one of the big expenses early on, don’t let it take you by surprise!
What is Earnest Money?
Earnest money is a deposit that counts towards your total cash due at closing. You pay this deposit (typically) in the form of personal check, (typically) within 3-4 days of going under contract. A title company usually holds this deposit, but sometimes the listing brokerage firm will hold the deposit.
If you terminate as allowed in the contract then you can recoup 100% of your earnest money. However, there is usually an administrative delay of a few days as the title company processes their paperwork.
You risk your money when you terminate in a way that the contract does not allow for.
Offering more in the deposit strengthens the offer; offering less weakens it. (Most sellers care more about the sales price than the deposit, though.)
How much should I offer for earnest money?
Just like a lot in real estate, the earnest money is negotiable. For homes listed in the local MLS (multiple listing service), the requested earnest money amount is specified. The seller can ask for any amount for this. What we have seen is that it usually lands somewhere between .5% and 1.5% of the listing price. So, if the list price is $500,000, the requested earnest money is somewhere between $2500 and $7500.
However, when writing an offer, you can present any amount for earnest money. If you offer less than the requested amount, sometimes the seller will question your financial ability to close the transaction.
Technically, you can offer things other than money in earnest. This could be a motorcycle, a gold watch, whatever you want. However, I’ve never actually seen this in a transaction!
Why do I need to pay earnest money?
Earnest money is a deposit to purchase a home. It shows your good faith to the seller and demonstrates that you have skin in the game, just like the seller does. Sometimes it may seem that the seller does not have anything to lose in accepting an offer but they do. They are usually taking their home off the market, missing the opportunity to attract other prospective buyers, and it is very difficult for a seller to terminate a purchase contract. From the moment that all parties have signed a purchase contract, the buyer can terminate and the seller cannot. In theory, the seller gets the funds if the buyer terminates. In reality, there are many ways for a buyer to legitimately terminate the contract and recoup 100% of the deposit that an earnest money dispute is rare.
When is earnest money due?
On the Colorado contract, the “alternative earnest money deadline” designates the deposit due date. It’s the “alternative” to presenting the money with the offer. Since the GREAT majority of contracts are done electronically these days, it is not really practical to present the earnest money with the offer. Some listing agents will request a copy of the earnest money check to go with the offer. In Colorado real estate transactions, this is the exception- not the norm.
Where does earnest money go?
As referenced above, the earnest money is usually held by a title company that the buyer and seller agree to work with. Oftentimes, the seller will pre-select a title insurance company to work with, but it is completely within the buyer’s rights to negotiate on which title they want to work with. In my experience, not all title companies deliver equal service. There have been companies that I have worked with that are late to process, slow to respond to emails and calls, and have calculated final figures incorrectly. I have had good experiences with Land Title, First American Title, and Chicago Title, among a select list of others. These companies are not discount operations. In the full picture of the entire transaction, title insurance and closing services fees are very small expenses and not a wise area to cut corners. They are holding your money. YOUR. MONEY.
Also referenced above, some brokerages hold the earnest money for their listings. This is not my preference, but if it’s something that the seller is not willing to negotiate on then it’s not worth losing your dream house over. In 7 years of doing more real estate transactions than 95% of my colleagues (#humblebrag), I have never seen a brokerage act inappropriately when holding the earnest money. (There was that *one* time that a certain brokerage did not return the funds for several weeks. I had to call them daily but they did get the money back to my client.)
No matter who is holding the earnest money, they hold the funds in a trust account “aka holding account,” and the holder of the funds cannot spend that money.
The holder of the deposit will not distribute the funds until either the transaction closes or they are formally instructed otherwise, with everyone’s signatures. For example:
- If the transaction is terminated and there is no dispute, the buyer and seller sign an “earnest money release.” The release instructs the title company or listing brokerage on how to return the funds. (I.e. who to send the check to, and if the check is split between multiple parties, how that is done.)
- If the transaction is terminated and there is a dispute, then the holder of the earnest money still cannot distribute the funds without either permission from all parties or court order. (Before you can get a court order, however, all parties must first go through mediation. So, in that case, in order for there to be a resolution, all parties must agree. You can read more on disputes by scrolling down.)
- If the transaction closes, then the funds are applied as a credit towards the buyer’s down payment. So, if the buyer is putting down $10,000 for the purchase and they pay $3000 in earnest, they will pay the remaining $7000 for the down payment on closing day.
Who gets the earnest money?
The section above covers this question is pretty well- “Where does the earnest money go.” If you are scanning through looking for quick answers, here ya go:
- A 3rd party holds the earnest money in a trust account, usually a title company
- If the transaction closes, the closer at the title company will apply the money to the buyer’s down payment. (When the earnest money exceeds the down payment amount then they refund the buyer the difference at closing.)
- In the cases when the deal does not close, the title company will distribute the funds as instructed in the earnest money release, which requires all parties’ signatures. (Unless there is a dispute all of the money goes back to the buyer.)
- If there is a dispute, the money stays in the trust account until either the parties agree or a court orders the distribution of the funds.
Are earnest money checks cashed?
Yes, these checks are cashed but not spent. They are held in a trust account (aka holding account).
When will I get my earnest money back?
If you are the buyer and you terminate the contract, your agent will present the seller’s agent with an release form that specifies how the buyer wants to get their refund. (I.e. who to make the check out to and where to mail it.) Once all parties have signed the release, you can also reach out to the title company to arrange a wire transfer to your account or to another title company if you are eyeing a different property. (No contract overlap allowed.)
If you are the buyer and the contract closes, then you get your funds back at closing in the form of a credit towards your down payment.
Can earnest money be cash? Personal check? Gift?
Usually, this deposit is a personal check, delivered to the designated title company or the listing brokerage office. Sometimes, the seller requests “good funds” instead of a personal check. This can include a wire transfer or a cashier’s check. You can pay with gift funds, however this may affect your loan. It is important to discuss and disclose all gifts and loans with your lender so that you do not undermine your ability to close.
What happens in an earnest money dispute?
If you are using the Colorado Real Estate Commission-approved contracts, then you have agreed to go through mediation if a dispute arises. In mediation, the resolution is legally binding but all parties have to agree in order to reach a resolution. This is before you can go through arbitration.
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