Earnest Money Must Come From Allowable Sources

Bill Gassett's picture
Earnest Money Needs to Come From Allowable Sources

What's Earnest Money?

When it comes to buying a home, one of the most essential topics for buyers to understand is earnest money. As a buyer you will be required to come up with what's known as an earnest money deposit.

The EMD for short is monies that are put in escrow by either a real estate broker or title company. The EMD is insurance for the seller that a buyer is not going to "walk from the deal" for no valid reason.

You could call the earnest money an incentive not to back out. Typically, earnest money deposits are between 1 percent and 5 percent of the purchase price - by no means chump change. Earnest money is almost always held by the seller's real estate agent or the title company. The earnest money is accounted for at the time of the closing.

Earnest Money and Down Payments Differ

One of the many confusing items when purchasing a house for the first time is how earnest money and a down payment differ. Buyers need to understand that these are not the same thing. Your down payment will be the monies you have liquid to put toward the purchase of the house. The remainder of the purchase price will be made up of the mortgage.

So for example, if you are buying a 400,000 dollar home and are putting ten percent down, you would be coming up with $40,000 of your own money. The remainder will come from the mortgage company to pay the seller at closing.

The earnest money, on the other hand, should be looked at as something like a security deposit when you are renting a home. When you don't fulfill your legal obligations as a renter, you will lose your security deposit. The same can be said about earnest money when you don't perform under the terms of the purchase and sale.

One of the most frequently asked questions from home buyers to real estate is in regards to how earnest money works.

Allowable Earnest Money

When entering into a real estate transaction, you must be identify the source of funds you're going to use to purchase a house. The funds have to come from allowable sources such as money you have in a bank account or a gift from a relative. The lender you are working with is going to check to see exactly where the money is coming specific.

Some sources are not allowed to be used, such as unsecured funds.

What many folks don't understand is that the same rules apply when it comes to earnest money deposits as well. These funds have to be coming from documented sources. So when you are going to be buying a home keep this in mind.

Not often, but occasionally buyers wonder if they can use a credit card to fund their earnest money. While the idea of funding earnest money may seem appealing, especially if you have a card that earns bonus points, it's not advisable. Some lenders may have a problem with a credit card being used. Make sure you check with your preferred lender before doing so.

Can a Buyer Lose Their Earnest Money?

The answer is a resounding YES! A buyer can definitely lose their earnest money, otherwise what would be the point of having it. There are three common scenarios where buyers will forfeit their earnest money deposit. They are as follows:

You waive common contingencies found in most real estate transactions, such as a home inspection or getting a mortgage. Many buyers will do this to sweeten their offer in a highly competitive real estate market. By removing these contingencies, a seller could look at a buyer's offer more favorably even if the offer amount was lower than another bidder. Waiving a home inspection, however, is highly risky. Quite often, problems are identified that aren't readily apparent to a layman.

Another common blunder is not following the contract dates. For example, the offer to purchase will say that you have to procure you financing by a certain time. If you miss that date and don't respond in writing, asking for an extension, you can lose your deposit. Given this, it's imperative always to monitor the critical dates in a contract.

Cold feet is another way buyers can lose their earnest money funds. Backing out of a real estate transaction for no reason has consequences. Buyer's remorse is a real thing that happens quite often in real estate sales. A buyer could also see something they like better.

Final Thoughts

Most of the time, buyers are prudent enough not to lose their earnest money deposit. They will follow the contract and, if warranted, will use any contingencies they have to escape the sale. In fact, a buyer not moving forward with a sale is not unusual at all. The home inspection is often one of the stumbling blocks that prevent a sale from taking place. Usually, it is something significant that has turned up or an accumulation of smaller items a seller is not willing to address.

First-time buyers would be smart to educate themselves on the ins and outs of earnest money. Making sure that your earnest money is coming from an allowable source is step number one. Hopefully, you have gotten something out of what you need to know about earnest money deposits.

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