Earnest money: what is it and how much is it used in real estate?Real-Estate Industry | Dec 16, 2022 | 10 min read
Earnest money is an integral part of almost every real estate contract or agreement. Earnest money is paid by the buyer to the seller presenting proof to the seller that the buyer is really interested in putting in the stakes. The money is given to the seller in good faith. It can either be directly paid to the seller of the property or it can be kept in an escrow account.
When the seller receives the earnest money, it is a confirmation that the seller has found a genuine buyer, and consequently, they take the property off the market. This money is not an extra cost toward buying the property. It is adjusted to the total money that you pay to the property owner or the seller.
How much earnest money is paid when finalizing a real estate deal?
Earnest money is a security for the seller. Putting the property on the market and listing it in various places can be costly for the seller. When the buyer and seller sign a purchase agreement, the seller removes the property from the market. It is assumed the transaction is going to proceed.
How much earnest money you pay depends on your market’s customs. Normally, it is anywhere between 1-3% of the sale price.
Example: you have agreed to pay 2% earnest money. The sale price of the property is ₹ 40,00,000. Then the amount that you’re going to pay as earnest money is going to be ₹ 80,000.
What happens with the earnest money if the deal falls through?
Earnest money can be a significant amount. Hence, you should fully understand the implications before you go ahead and make the payment to the seller.
Sometimes, the deal falls through even after paying the earnest money. The buyer may cancel the sale. The seller may not be able to keep their end of the bargain.
If the buyer is not able to arrange the rest of the payment or if at the last moment, they cancel the deal and decide not to buy the property, the earnest money remains with the seller. This is because using this money, they can recover the expense of taking the property off the market and restart the process of putting it back there.
Or maybe the seller changes their mind at the last moment and refuses to sell the property or there is damage in the property that wasn’t mentioned during the bargain or the inspection. In a case when it is not the fault of the buyer and the deal is falling through because of the seller, the seller needs to return the earnest amount to the buyer.
Some things to keep in mind when making an earnest money deposit
As mentioned above, depending on the sale value of the property the buyer may pay a significant amount in the form of earnest money. Since there may be reasons the buyer may not be able to recover the paid amount if the sale gets cancelled, it helps if certain precautions are taken.
Avoid giving the it directly to the seller. Get a receipt of the payment. Pay the amount to a reputable third-party such as a legal firm, an escrow company, a title company, or a person or an agency that both parties have full faith in. Make sure that the money is deposited into a separately maintained trust account. Get an agreement signed about what will happen with the earnest money if the deal is cancelled.
Remember that it is a safety net both for the buyer and the seller, considering the fact that this amount will be adjusted into the overall payment. The buyer gets an assurance that the seller is not going to sell the property to someone else. The seller gets the assurance that if the buyer backs down they will have enough money to put the property back on the market.
How can you further safeguard your earnest money deposit?
You will be signing a contract while handing over earnest money. Make sure the contract includes terms to handle other financing and inspection contingencies. It must be included in the contract what will happen if the buyer is unable to arrange the remaining finance or if a defect is discovered after the deposit has been made (something that was not discovered before the deposit).
On the seller’s side, the buyer needs to make sure that a thorough examination of the property is completed by a certain date and that the buyer adheres to all the deadlines. If these deadlines are not met, the buyer forfeits their claim to the earnest money as well as loses the property. Both parties must ensure that all the deadlines are met and every possible information about the property is available to both parties and both parties are aware of such bits of information.
Earnest money is considered token money to finalise a real estate deal. It is a sure-shot way of deciding that the real estate deal is finalised. Both parties can rest assured that they don’t need to explore the market further. Provided certain precautions are taken both the buyer and the seller enjoy full protection against losing the money. If the deal doesn’t fall through the money goes to the party that has been wronged or that has incurred a loss. If the deal goes through, the money is adjusted with the total amount the buyer pays to the seller. Earnest money is not an additional cost to the buyer.