One of the hottest topics for discussion right now and a question I literally get…
So what is an Earnest Money Deposit and what does it do?
Your Earnest money, or good faith deposit, is a sum of money you put down to demonstrate your seriousness about buying a home. In most cases, earnest money acts as a deposit on the property you’re looking to buy. You deliver the amount when signing the purchase agreement or the sales contract.
Think of it as “Hey we are serious about wanting to purchase your home Mr. and Mrs. Home Seller” and here is our show of good faith that we are indeed serious about buying your home.
When we are buying a home from somebody, they are taking that home off the market and not entertaining any more offers for their home from any other possible homebuyers. They are indeed selling that home to you!
This prevents the whole cold feet scenario and people changing their mind about wanting to buy the home. If you have a whole $3000 dollar earnest money deposit and all of the sudden have a change of heart, it is in that seller’s right to keep your earnest money. This is what makes it such a big deal to make sure you have done your homework on the house you want.
Earnest Money and Closing Costs:
So here is something cool: Your Earnest money actually goes towards your down payment/Closing Costs: Let’s look at a quick example of how this works.
Let’s say we are purchasing a $400,000 home and for this particular home we are putting 5% Down payment:
So 5% of $400,000 is a $20,000 Down Payment:
Let’s say for this example, your Earnest Money you decided to put into escrow is $3000.00.
Let’s say we are also receiving a seller credit and the seller’s have agreed to pay for all of your closing costs. (YES, that happens and we will discuss that in different posts 🙂
So, the only funds we are required to bring to closing are the down payment funds. This means at closing and finalizing the purchase of the home, the remaining funds you would be required to bring to closing would be $17,000.
$20,000 minus the initial Earnest Money Deposit of $3000.00 = $17,000.
Things to Watch Out For With Earnest Money!
The Anti Money Laundering Law requires lenders to be able to source and paper trail all funds that are being used in the transaction.
What does this mean? Let’s look at a different example:
If you have $3000 of cash sitting in your safe at home and decide to use that as your earnest money deposit. The Lender has no way of knowing where those funds came from and therefore we can use them. So, if funds are used for Earnest money that the lender can not source and show where they came from, we have to back those funds out. So, in this example, you would have to come in with an additional $3000 at closing and you would receive your funds back (refunded) to you.
Using a credit card or money order for your Earnest Money Deposit:
Again, we have to be able to source and show where the funds came from. So if this is the case, make sure you keep all applicable receipts so the funds can be sourced and paper trailed.
Gift Funds are typically not an issue for the Earnest Money Deposit, but again, we have to be able to track it. We will require a gift letter, this is something the lender provides, and also usually be able to source that the person giving the gifts had the ability to do so. Depending on the loan program being used, proof of the donors ability may be required (Bank or asset statements) Showing they had the funds available to give the gift.
With a little preparation and not rushing the process, you can set yourself up for success so tracking the Earnest Money Deposit does not turn into a nightmare. When in doubt ask questions to your lender (Not Real Estate Agent) in regards to how to properly track our Earnest Money Deposit.
There you have it! Earnest Money 🙂
Aaron DeHart has been a mortgage loan originator since 2003 and with the help of his fantastic team has helped over 3000 families achieve the dream of home ownership.