Earnest Money: How much? When? Why?
When we draft an offer, we will need to know the following terms;
- Purchase Price in offer,
- The duration of the Due Diligence Period,
- Closing Date,
- Financing (if any), and
- Amount Earnest Money to be deposited when agreement is binding.
With all this, we are able to send you a pretty complete offer, but people are often stumped by Earnest Money. How much is enough? When do they get it back and under what circumstances?
Let’s start of by defining what Earnest Money is not:
- Earnest Money is not the Down Payment. The Down Payment is the cash your lender will require that you bring to a closing. Down Payment plus your closing costs equals the amount you will need to bring to closing.
- Earnest Money does not belong to the Seller unless it becomes liquated damages. It is typically held by Selling Broker, Title Company or Closing Attorney. It is only paid to a Seller when Buyer fails to close and/or is in breach of contract.
- You do not get your Earnest Money back at closing. It is applied to the Purchase Price
So, What is Earnest Money?
- “It is customary for a buyer to deposit a sum of money to show a buyer’s commitment to purchasing the property. This is commonly referred to as earnest money. Some new construction contracts may refer to earnest money as a construction deposit.” (The Red Book on Real Estate Contracts in Georgia, 2012, Page 175, Seth Weissman and Ned Blumenthal)
- It can be tangible property if Buyer and Seller agree.
- Most importantly, if you fail to terminate during your Due Diligence Period or the Buyer fails to closing as stipulated, Earnest Money becomes Liquated Damages. In other words, if you breach the contract, Earnest Money is the limit of your damages under the contract – sort of. The Seller would have to accept the Earnest Money as liquidated damages. If he did not accept (deposit) the Earnest Money, the Seller could pursue other damages.
Rules of Thumb
- Some say it should equal one month’s pay. We think this is probably not enough in most situations involving most property in our market areas.
- It should be enough to sting if you lose it, but not create any major financial risk.
- It should be an amount that would incentivize a seller to commit to the buyer making an offer.
- We think Earnest Money should be 2% to 3% of Purchase Price.
Here are prudent amounts organized by price segment:
- Sellers primarily care about the Purchase Price, Speed of Due Diligence and Closing, and the Certainty of the Closing. The certainty is related to earnest money. In your offer, exceed the standard. Demonstrating to a Seller that you have resources on hand is a good way to get the best consideration of your offer.
- We had a deal several years back where the buyer wanted a significant discount on $1 million deal. So, how might one prove they have the money to close? $1 million earnest money will do the trick in this situation.
- If you are not working with a fine brokerage like ours, you can stipulate that a Closing Attorney or Title Company holds earnest money.
- If you are divesting productive investments to come up with the earnest money you need, maybe you are providing too much earnest money or buying too much house.
Construction deposits are a separate line item in many contracts to purchase new houses. This is typically tied to the improvements a builder is making specifically for a buyer. Therefore, there should be a least a dollar to dollar relationship. If the builder is making $10,000 of additions and alterations (i.e. change orders), construction deposit should be at least $10,000. It is more than likely going to be about 5% to 10% above the amount and non-refundable.
Please contact us with any questions and we welcome your comments.