Once home buyers find a home they love, they declare their commitment to the seller with a sizable chunk of change known as an earnest money deposit. Yes, it sounds so sincere and serious because it is—and if you get it wrong, you could lose thousands of dollars. To scare you straight, here are eight mistakes with earnest money that home buyers often make. To ensure you don’t end up among them, read on to avoid these snafus.
How much earnest money is normal?
Before we get into the potential mistakes that home buyers often make when it comes to earnest money, it’s important to understand how much earnest money is normal, as well as typical earnest money percentages.
First, make sure you fully grasp what an earnest money deposit (EMD) is—namely, proof that a real estate buyer is earnest, or committed to completing a sale by having skin in the game. The amount of earnest money is negotiable between the buyer and seller, but is usually about 1% to 2% of the purchase price (although it can shoot up to 10%). This good-faith money is generally held by the real estate seller’s broker or in escrow by a title company, to be used as a credit toward the down payment and closing costs.
Mistake No. 1: Offering too little of an earnest money deposit amount
In an aggressive real estate seller’s market, many homes receive multiple offers from anxious buyers. So read on if you’re asking yourself, “how much earnest money should I put down?”
For a home buyer’s offer to stand out, Robyn Porter, a Realtor® in the Washington, DC, metro area, tells her clients to include an EMD in their offer that will get a seller’s attention. On a $500,000 home, Porter suggests earnest money of $20,000 to $25,000, or 4% to 5% of the purchase price, depending on the number of competing offers. Your real estate agent should be able to recommend an appropriate amount of earnest money to go with your real estate offer.
However, “I do caution buyers that the earnest money is in jeopardy should they default on the purchase contract, so they should be very serious about wanting the home,” says Porter.
Bottom line for buyers: Weigh losing the earnest money against the possibility of losing the home.
If putting a high earnest money deposit into escrow scares you, remember you’ll have to come up with the down payment and closing costs 30 to 45 days after making an offer, anyway.
“The earnest money amount is just a way for a buyer to pay part of the down payment upfront,” says Porter. “On a $500,000 mortgage, a 15% down payment is $75,000, so a $25,000 EMD shouldn’t be a hard pill to swallow.”
Mistake No. 2: Removing contract contingencies
A big mistake real estate buyers make with their earnest money deposit is agreeing to remove contingencies that give them wiggle room they may legitimately need, says Jeremy Colonna of Matchpoint Funding.
For instance, if buyers agree to remove a loan contingency and their financing falls through, they’ll lose their earnest money.
“Never give up your right to cancel your purchase until you are 100% certain that you’re going to be able to close,” says Colonna.
Other contingencies—such as those regarding a home that’s uninsurable, inspection issues, a problematic title search, or a house appraisal that comes in too low—also protect a buyer by allowing the penalty-free canceling of a contract.
You may have a due diligence period built into your contract, as well. In some states, such as California, you may have a default number of days for a due diligence period, which gives you a set period of time to decide if you want to move ahead with a deal.
“There may be other instances where the buyer can legally get their EMD back, but these contingencies are the most common,” says Joe M. Lopez, a Realtor in Texas.
Mistake No. 3: Ignoring contract timelines
In some cases, the seller’s real estate agent includes a timeliness clause with a hard date for closing, after which the earnest money is nonrefundable.
“Ensuring that you as a buyer stay on the schedule dictated by a contract can assist with not losing your earnest money deposit,” says Raena Casteel of Arizona’s Casteel Realty Group. This means carefully tracking how long you have to terminate the contract for valid reasons.
Mistake No. 4: Buying as is and not knowing the risks
A buyer who purchases foreclosed properties should be cautious putting down significant amounts for earnest money, says Marsha Bowen Washington, a Realtor with Coldwell Banker in Northern New Jersey.
These properties are typically sold as is, so the sellers will stipulate that the earnest money deposit is nonrefundable. As a buyer, protect yourself by doing your due diligence before making an offer on such a property, because if you don’t, you’ll have to kiss your deposit goodbye if you decide to bail.
Mistake No. 5: Blindly voiding the contract
When a sale falls through, both the buyer and the seller need to sign a document voiding the sales contract. If a seller won’t release all of the earnest money that a buyer feels legally entitled to, that buyer can refuse to sign the document and essentially make the home unsellable by putting a blemish on the title.
In other words, buyers should never, ever sign this contract unless they’re sure the real estate seller’s broker or a title company will give them back all of the deposit they deserve.
Mistake No. 6: Impulsively purchasing a home that’s not a good fit
This may seem like a no-brainer, but it’s easy to get swept away by a home’s cool features when you first see it. A buyer may put in an offer only to realize days later that the soaking tub may be fabulous, but the kitchen isn’t functional. So do your due diligence, and make sure that you’re 100% serious about buying a home before making an offer and submitting your earnest money.
“If you get cold feet and back out, it’s more likely that you won’t get your money back,” says Casteel.
Mistake No. 7: Not knowing when to let it go when it comes to the earnest money deposit amount
“I had a buyer decide he no longer wanted a home about a week before closing,” says Porter. “He broke up with his fiancee and didn’t want to buy a property where they were going to start a life together. He was willing to lose his $10,000 in earnest money, and he did.”
Personal problems may be very serious to you, but they’re not a valid reason to cancel a home purchase. And if you’re bailing on a deal with no legal justification, fighting to get your earnest money back from escrow is probably a waste of time. Just accept that it’s gone and move on.
