Why it is important to use earnest money when home buying
If you're in the market for a home, you will need to be prepared to submit a cash deposit with your offer to purchase. This deposit is called “earnest money” or sometimes a “good faith offer.” Not to be confused with a down payment, earnest money is a separate payment and is used to assure the seller you are serious about the purchase so they can proceed with the offer you've made.
How an earnest money deposit differs from a down payment
Although an earnest money deposit is paid to the seller like a down payment, they are given at different times for different reasons.
- Down payment: The down payment is a portion of the selling price you pay out of pocket when you actually buy the property from the seller. The remainder of the funds needed will come from your home loan. The size of your down payment may determine the interest rate your lender charges on your loan.
- Earnest money deposit: An earnest money deposit always accompanies your offer to purchase a property. The funds are deposited into a non-interest bearing escrow account held by a neutral third party. Earnest money deposits are refunded if the sale falls through at the fault of the seller. However, when the sale and transfer of the property occurs, your earnest money will be given to the seller as part of your down payment.
Using earnest money as home-buyers insurance
Typically, earnest money is used in real estate negotiations to ensure good faith between the buyer and seller. The earnest money deposit is usually held by a neutral third party in an escrow account and is used to motivate both parties to remain in the contract, regardless of a better opportunity coming along. For the seller, the deposit indicates the buyer is serious about buying the home and won’t back out of the contract. For the buyer, the deposit contractually binds the seller from being able to sell the home to someone else. Once the sale is finalized and the property ownership is transferred, the good faith offer is given to the seller as part of the down payment.
How earnest money is used in real estate transactions
The earnest money can be a good faith offer as low as a dollar and up to around three percent of the purchase price you are offering. The actual amount will probably depend on what is customary in your market area. It could also be influenced if there are other buyers competing for the same home. The amount of the earnest money deposit paid should be included in your offer to purchase (also known as the purchase contract). The purchase contract should also state that the buyer will receive his or her good faith offer back if the seller breaks the contract through no fault of the buyer. Sellers, on the other hand, may want to include a forfeit clause, which gives the seller the earnest money deposit as compensation for their time in the event the contract is terminated by the buyer.
Start the home buying process with Citizens Bank
Once you have put down your earnest money deposit, Citizens Bank can help you take the next step. We offer many home loan products to help you complete your home purchase quickly and smoothly. Discover helpful home loan tools to help you find and purchase your dream home. Begin the mortgage application process online by answering a few questions, or speak to a Home Loan Advisor.