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Real estate terms: Earnest money deposit

[fa icon="calendar"] May 9, 2020 11:41:01 AM / by Eli Karpovski

Eli Karpovski

Every real estate transaction should have a reasonable amount of Earnest money deposit from the buyer. Earnest money deposit is commonly known as the down payment when a mortgage is involved. This deposit can range anywhere from as low as 1% of the purchase price to any percentage, up to and including, 100%. 

What makes the amount reasonable?  There are many factors that can determine what is reason for a seller to accept an offer, including:

  • Market condition
  • Number of offers
  • Days on market
  • Type of loan (if applicable)

If the market is strong and many offers are being presented to a seller, then theearnest money seller may look at the deposit more favorably, the higher it is. When a loan is required for the buyer to purchase a higher down payment will increase the chances that the buyer will be approved for a loan.

What are the common numbers? Banks have set break points for down payments. It is typical for conventional loans to have at least a 20% down payment. The reason for this is, banks don't usually hold the mortgage post closing. Rather, they sell it off to the government so long as the loan meets Fannie Mae or Freddie Mac guidelines. 

Certain loans will allow a buyer to purchase a home with as little as 1% or more commonly 3%. VA loans or FHA loans have special guidelines. In every loan both the buyer and the property must qualify for the bank to issue a commitment letter. In VA and FHA loans there are additional requirements for both the buyer and the property compared to conventional loans. In some cases, sellers will not accept these loans because the property will not qualify. Banks will have additional inspections made by third parties to verify that the home meets the standards for these loans. If the home does not, the seller would have to make repairs or modifications.  Most sellers just want to sell and move on, so this could kill a deal. If this is the case, the seller would need to go back and start over with another offer that doesn't involve VA or FHA loans. 

What happens to deposit money if your deal falls apart?  In most cases, if the deal falls apart then the buyer loses the deposit to the seller. This is not necessarily true. Every sales contract has at least one contingency and a due diligence period. The contract becomes more firm once the due diligence period has concluded and all contingencies have been met. If that were the case and the deal does not close, most would think that the deposit money is awarded to the seller. Well, not so fast, I have never seen a deposit released without a fight.

Usually, the attorneys will argue about the deposit for some days and maybe as long as weeks. If a negotiation does not come up in those discussions or a settlement cannot be reached a lawsuit is surely coming. 

More often than not, sellers release the funds back to the buyer in whole to avoid the cost of litigation. If a lawsuit is initiated then the deposit is most likely paid into court. It sits in the court's escrow account until a judgement is made. This can last months to years depending on the attorneys. 

As a seller, it's best to get the largest deposit possible. This gives you better indication that the buyer is serious and will stay the course to purchase the property in contract. 

No matter what side you are on the right agent and attorney will make your deal. Looking for some help? Click the appropriate link below. 

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Topics: Glossary, Selling, Buying

Eli Karpovski

Written by Eli Karpovski