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Earnest Money Deposit: What Is It and Why Is It Important?

Friday, January 10, 2020
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If you’re considering putting your home on the market, one of the questions you need to ask is, “What is the role of an earnest money deposit when I sell my house in Atlanta?”

In reviewing offers for your home, you need to consider a buyer’s earnest money deposit. Earnest money is referred to as “good faith money” because it is a demonstration of the buyer’s serious intent to buy the property. It also serves as a protection for the seller in the event the buyer gets cold feet and backs out of the sale without a valid reason.

Earnest money deposit vs. down payment

Many people confuse earnest money with the down payment for the home. One can say the deposit is a down payment for the down payment, as both eventually go to the full payment of the property. However, while a down payment is often required by the bank as part of the buyer’s home loan, a deposit is a voluntary initial payment offered by buyers to make their bid more attractive to sellers.

Unlike a down payment, the deposit amount solely falls at the buyer’s discretion, although it may be negotiated with the seller. The typical figure is around 1% to 2% of the sale price, but you as the seller may negotiate for more than this.

The deposit, along with the down payment, typically goes to the escrow account that will be opened once you and the buyer sign a purchase contract. It may also be paid to your agent, but it can’t be given directly to you. The payment often comes in the form of a personal check. If the check is cashed by your agent, the money is deposited into the escrow account.

The full payment for the home, including the deposit and down payment, will be released to you upon closing.

Earnest money deposit and contingencies

The purchase contract that you sign with the buyer will most likely include contingencies, which are essentially conditions that need to be met before the sale can be finalized. Most buyers include them in the sales contract to protect their interests in case issues come up during the buying process. As the seller, you may also include your own contingencies for your protection.

The most common buyer’s contingencies include:

  • Financing contingency – The buyer may back out of the sale if they are unable to obtain the mortgage terms they were expecting, including the amount of the loan, the interest rate, and the duration of the loan.
  • Inspection contingency – The buyer will have the property inspected by a professional. If major issues are revealed during the inspection, the buyer may renegotiate the price, or ask for concessions, or get out of the sale.
  • Appraisal contingency – As part of the loan process, the buyer’s lender will have the property appraised to determine its value. If the appraisal comes up lower than the agreed selling price, the buyer may renegotiate the price or back out.

These contingencies come with a deadline, before which they have to be removed. If issues arise in any of these contingencies, the buyer can back out of the deal and get the earnest money back before the deadline.

How can an earnest money deposit protect you?

When you sign a purchase agreement with a buyer, you need to take your property off the market, unless you and the buyer agree that you can continue to market it “Under Contract.” If the buyer backs out of the deal, you lose the opportunity to sell the home during the period the contract was in force. In such case, you may keep the earnest money deposit as compensation for the opportunity you lost.

However, buyers may get back their earnest money if they have legitimate reasons to end the contract, specifically if any of the contingencies included in the contract were not met. For example, if serious issues were found during the inspection and you cannot agree on a resolution, the buyer may end the contract and get back the deposit.

In cases, however, where the buyer backs out simply because he or she has a change of heart, you’re entitled to keep the deposit. It could also be that the buyer ran into a problem with one of the contingencies and wants out of the contract but failed to inform you within the given deadline. You may argue that the buyer has forfeited the deposit in your favor.

Returning the deposit

Returning earnest money deposits can be contentious. To avoid conflicts and misunderstandings, the sales contract must be clear about how the deposit should be managed.

Likewise, you can take a few steps to protect the deposit. These include:

  • Cashing the check so the buyer can’t clean out the account and cause the check to bounce
  • Familiarizing yourself with all the details of the buyer’s contingencies, including the deadlines
  • Adding a “Time is of the Essence” clause, which states that you can keep the deposit if the buyer is not able to meet the deadlines mentioned in the contract, including the closing date.

In selling your home, make sure your interests are protected at all times. Work with a realtor who can give you expert guidance. Call me today at 404.550.5113 or send an email to Natalie(dotted)Gregory(at)Compass(dotted)com.