Earnest money explained
When you are preparing your offer to purchase, one item for consideration will be how much earnest money you should to offer to the seller. This figure is an important figure but there is no set amount and no particular formula for determining how much you should offer.
The need for earnest money flows from the law of contracts. In order for contract to be formed certain elements must be to fulfilled. One of the elements is called "consideration" . Consideration is an exchange of something for something else. In this case, it is the exchange of a deposit of money for a promise to sell. Each party has given up something in order to form the contract. Without "consideration" no one is bound to the terms of the agreement because there is no contract.
Beyond the contractual reasons for having earnest money, it also plays an important role in the negotiation process. The amount of earnest money that you offer can determine whether or not the seller agrees to the terms of the sale. Higher earnest money amounts suggest a higher level of commitment from you and a lower likelihood that you might default on your obligations to purchase the home.
So, if you are less likely to walk away from purchasing a home, the seller is more comfortable in removing the home from the market on your behalf. Remember that every minute of every day that the home is listed as "under contract", the seller forgoes other potential buyers. It is important for the seller to know you are very serious about buying a home.
What happens to the earnest money? At closing the earnest money will be applied to your side of the balance sheet on the closing statement. In other words, you, as a buyer, are credited for the amount of the earnest money.
Are you always guaranteed to get your earnest money back if you walk away from the purchase? No you are not. However, as long as you have fulfilled your obligations in good faith and there is an unfulfilled contingency remaining on the contract you have a usually have the right to receive your earnest money back should the deal fall through.
The types of contingencies that warrant the return of earnest money are many and are beyond the scope of this discussion. In structuring your offer, your agent will help you insert the appropriate contingencies for your situation. One of the most common contingencies is that the purchase is contingent upon inspections of the house returning satisfactory results for the buyer.
Earnest money is also the primary "remedy" for the seller should you default on the purchase. After all, if you default, undoubtedly the seller will incur expenses and pay the "opportunity cost" of not having had the home available for other potential buyers.
My advice, when it comes earnest money, is that if you really want a certain home, offer a strong earnest-money sum with the just the minimum number of contingencies necessary to protect your position.
If you want your offer to be accepted, find a way to make your offer as appealing as possible. Offering a higher contract sales price is only one of many strategies to achieve this. Balancing earnest-money and contingencies can be just as important.
Chris DeLoach, ABR