Every day, The Trembley Group Real Estate Professionals field all sorts of questions from their clients. Some common ones, especially from first-time buyers, deal with earnest money. What is an earnest money deposit? Is an earnest money deposit just another name for a down payment? Where does an earnest money deposit go and why is it important?
Both earnest money deposits and down payments are critical parts of the home buying process, but they are certainly not the same thing. However, in both cases, the more money offered the better the chances of the seller accepting the offer and the better the chances of the buyer getting the home they want. It’s one more way of making one offer stand out over another. So what is the difference between escrow deposit and a down payment?
What Is An Earnest Money Deposit?
To show a seller that an offer is serious and made in good faith, a prospective homebuyer includes a check with their offer. The check is typically 1-2% of the purchase price. This is known as the “earnest money deposit” and is an integral part of a buyer’s offer. The seller may get to keep that money if the buyer pulls out of the deal for a reason that isn’t allowed under the conditions of the purchase contract, such as the buyer simply changing their mind after the contract is ratified. A strong earnest money deposit essentially acts as security and incentives the seller to accept an offer and take the home off the market versus waiting for offers from additional prospective buyers.
The Myrtle Beach and Grand Strand real estate market is a seller’s market and The Trembley Group Sales Executives are dealing with more and more transactions involving multiple offers. If a home seller has several offers, a larger earnest money deposit could set one offer apart from the competition. A good sales executive might be able to negotiate a lower deposit but as a general rule, an adequate earnest money deposit is as little as a seller is willing to accept and as much as a buyer is willing to offer.
A purchaser must be sure their bank account has sufficient funds before writing an earnest money a check. The earnest money deposit is typically turned over to the real estate broker after the contract is ratified and is deposited shortly thereafter. The money is placed in an escrow account until closing. If the deal goes as planned, the earnest money is usually applied towards your down payment. In the event a purchaser negates the contract due to one of the contingencies in the offer, such as failing the home inspection, the earnest money is usually returned. The individual making the offer should discuss the terms with their Sales Executive and make sure they fully understand the conditions for a refund.
What Is An Escrow Account?
Few words are used as much and misunderstood as much as “escrow.” A Trembley Group Real Estate Sales Executive may refer to an escrow account that a mortgage lender will require, or someone may say that a home sale is in escrow, or a buyer may be told that their earnest money deposit is being held in escrow. All are a proper use of the word escrow and all mean something different.
What is escrow? Escrow is a legal concept where a financial asset is held by a third party (the escrow agent) on behalf of two other parties that are in the process of completing a transaction. The funds or assets are held by the escrow agent until it receives the appropriate instructions or until predetermined contractual obligations have been fulfilled. Money, funds, a deed, and other assets can all be held in escrow.
An escrow is a contractual arrangement in which a third party receives and disburses money or documents for the primary transacting parties, with the disbursement dependent on conditions agreed to by the transacting parties, or it can be an account established by a broker for holding funds on behalf of the broker’s principal or some other person until the consummation or termination of a transaction; or, a trust account held in the borrower’s name to pay obligations such as property taxes and insurance premiums.
When parties are in the process of completing a transaction, there may come a time when one party is willing to move forward if it knows with absolute certainty that the other party will be able to fulfill its obligations. This is where the use of escrow comes into play.
Real estate professionals like to talk about a real estate sale being “in escrow.” In this use of the of term “escrow,” the closing attorney is the escrow agent and it is the closing attorney’s responsibility to make sure all the conditions outlined in the purchase and sale contract prepared by the real estate sales executive are satisfied and met. In the process of escrow many conditions and steps must be satisfactorily completed before closing can occur and ownership of the house is transferred to the purchaser. Some of the many steps and conditions are interdependent and must be done in a specific order. It is the closing attorney’s
Escrow as defined by a mortgage lender deals with a mortgage lender wanting to be certain that their investment (the mortgage loan) is protected. There are only a few claims that can take precedence over a mortgage. One is property taxes. If a homeowner does not pay the real estate taxes on their home, the home can be sold for back taxes and the mortgage lender is out of luck. To protect their investment, mortgage lenders require a borrower to pay 1/12 of the real estate taxes each month in addition to the principle and interest payment. The extra payment is placed in an escrow account and the lender pays the taxes when they come due.
A mortgage lender also protects their investment from the risk of the property being destroyed by fire or storm by requiring a homeowner to purchase homeowner’s insurance. To assure the insurance premium is timely paid, the lender will frequently require 1/12 of the property insurance premium to be paid each month in addition to the principle, interest, and property tax payment. The insurance premium is held in escrow by the lender and the annual insurance premium on the homeowner’s behalf by the lender.
When a purchaser makes an offer on a home through a Trembley Group Real Estate Sales Executive, the earnest money that accompanies the offer is held by the company. Once the offer is accepted, the earnest money is deposited in the company’s escrow account and is held in trust (hence the term, “trust account”).
What is a down payment?
The down payment is the amount of money that the lender requires to put towards the purchase of a property. Normally based on a percentage of the total sales price, the amount is typically established early in the loan application process with the lender. While down payment amounts can vary from 3.5 percent for an FHA loan to upwards of 20 percent for certain conventional loans, normally the source of the money must be verified and approved by the lender. For more information about the down payment, purchasers are encouraged to discuss the mortgage process with a Trembley Group Sales Executive and one of the company’s trusted business partners.
The higher down payment, the greater the chance of being approved for a mortgage. In addition, the greater the equity in a home, the smaller the monthly mortgage payment.
Three Scenarios Where a Buyer Could Lose Their Earnest Money
The Buyer Waived Contingencies
In highly competitive markets, it’s becoming more common for buyers to waive contract contingencies regarding financing or inspection. Some purchasers may be tempted to waive contingencies if they’re “really hot” for a particular property. It will make a purchaser a more attractive buyer, but it also comes with major risk. That’s right, the earnest money deposit may be lost.
The financing contingency guarantees that a purchaser gets their money back if the financing is not approved. With the inspection contingency, a contract can be declared null and void (and get the deposit returned) if there are issues discovered in the home inspection raise “red flags” that makes a purchaser change their mind about purchasing a particular home.
If contingencies are waived and there are financing or home defect issues, it will not be able to get your deposit back if you abandon the deal. Therefore, it may not be a good idea to waive the inspection contingency unless the purchaser is planning on tearing the property down. Or, if a purchaser thinks they will be in a competitive offer situation, an inspection could be completed before submitting an offer. That way you know ahead of time if there are any serious issues with the home that would prevent you from purchasing it, and can submit an offer with the home inspection contingency waived. As for the financing contingency, waiving it may be the only way to compete with all-cash buyers. However, bank approval must be a certainty.
The Timeline Outlined in the Contract Was Not Met
A contract usually sets specific time frames in which financing must be secured and inspections must be completed. Trying to void the contract after any of these deadlines have passed, will likely cause the earnest money to be to be forfeited. Generally speaking, as long as a good-faith effort has been made to adhere to the timeline, sellers will grant a reasonable extension if the lender needs more time or there are other extenuating circumstances that cause delays. Any extension must be made in writing and signed off by both the seller and the buyer.
The Buyer Got Cold Feet
If a buyer has a change of heart about the home they’re buying, but there’s no problem with the property or the financing, it is unlikely the purchaser will get their deposit returned. The earnest money deposit serves as protection for the sellers when they take their home off the market. If late in the game a purchaser decides they don’t want to close the purchase, the seller gets to keep the earnest money as compensation for the time and money they have to spend on listing their home again and looking for another buyer.
However, if a purchaser changes their mind, it is possible that their liability may not be limited to losing the earnest money deposit. The sellers could sue for specific performance and all the associated tertiary costs including legal fees. For instance, sellers may have moved out of the house and that they staged the home by bringing in additional furniture. When the house goes under contract, they move the furniture out so that they don’t incur further staging costs. If the buyer backs out for a reason not stipulated in the contract, the purchaser could be liable for additional costs in excess of the earnest money deposit.
Purchasing a home is not a simple process. It should not be started without the experience and expert advice of professional Sales Executives at the Trembley Group Real Estate.
At The Trembley Group, we pride ourselves on being the experts at more than just selling real estate. We are local residents, some of us have been here for a lifetime. The rest of us will be here until the end of time. We love living, working, and playing in the diverse backyard of Coastal Carolina, and look forward to helping you live and love your dreams soon too. Please reach out to us by phone or email for personalized service and one-on-one advice.