Representing a good-faith plan to purchase, earnest money is a deposit the homebuyer makes to secure the transaction of a finalized purchase agreement.
What else do first-time buyers need to know about Earnest Money?
However important, this part of a home purchase transaction can sometimes be confusing to first-time home buyers.
This article will help clear much of that confusion by breaking down common misconceptions and raise awareness of the benefits and importance of the earnest money offering.
First up, let’s clear up what earnest money is and what it isn’t.
Earnest money vs. down payment
Sometimes people confuse the earnest money deposit with the down payment since they are similar in some ways – for example, both are monies promised at the front-end of a financial transaction: a loan qualification or an offer to purchase. But, it’s important to understand these two payments are different applications and the buyer is responsible for both.
- Earnest money is a promise on a purchase - barring any challenges on appraisal or inspection. The amount offered is not set in stone, but in a competitive seller’s market a buyer will want to put his/her best foot forward. And, in most cases, these payments can roll over to your closing costs.
- Down payments, on the other hand, are related to the financing of the mortgage which is needed to purchase a property – unless you’re one of the lucky few who can pay cash out for a property and do not need to borrow money from the bank. Down payments can range (on average and depending on your qualifications) between 3% - 20% percent of the sale price.
WHY is earnest money important?
When an agreement is made for the sale of a home, it does NOT mean that the party intending to buy the home must move forward. They are protected by a verification process, including an inspection and appraisal, that can expose issues with the property. Since the arrangement is not yet completely solid, the earnest money deposit is good-faith evidence that the buyer does want to buy. In turn, the seller pulls the home off the market in order to complete an appraisal and inspection.
When is earnest money paid?
Typically earnest money is deposited within 2 business days of the acceptance of an offer.
How much earnest money does a buyer need to have?
Traditionally in Minnesota, the amount is 1 percent of the total sale price of the home. Additional factors are considered, though, including the seller’s requests, advice from REALTORS®, and the current market. Given those considerations and others, this deposit could be as high as 5 percent or more, or as little as $500. In the case of a cash offer, most sellers will expect to see 10 percent of the total sale price.
But again, in a competitive market, any professional worth their weight will tell you to aim as high as you can since you will be able to roll these monies toward closing costs and/or a down payment; reducing amounts due at the closing table.
Bear in mind, earnest money can be just a piece of the negotiation process. In a neutral or soft market, when the buyer suggests greater earnest money, sometimes the seller will be willing to reduce their sale price. If that’s the case the buyer’s real estate agent may suggest increasing the amount.
More sizable earnest money deposits must often be verified, in which case it is important to have had the money in a bank account for at least a couple months; the verification process may require the buyer to submit some documents to the mortgage lender.
The buyer should consider their finances closely, though, before providing more since these funds will be held in escrow until closing — in today’s market that could be an average of 1-2 months.
Beyond negotiation, there are other reasons the amount of earnest money in Minnesota varies.
Typically the earnest money requirements fluctuate based on the market: in a seller’s market, you could be asked for 2, 3 or even 5 percent. In a buyer’s market, some sellers will accept under 1 percent. And, for those sellers willing to work with a buyer who has not been pre-approved or has other questionable financial challenges, a seller may request a non-refundable transaction or upwards of 10% in earnest.
Every situation is different, and that is why having a licensed real estate agent who is also a member of NAR (otherwise known as a REALTOR®) is good to have in your corner.
What is the Minnesota law on holding of earnest money?
Brokers must maintain a trust account at a credit union, bank, savings association, or industrial loan and thrift firm. When the buyer gives the broker or agent the earnest money funds, they must be deposited in the escrow account, as indicated in the contract. They should be deposited in that account quickly — no more than three days after final signing of the contract or payment of the earnest money.
Will the potential buyer get the earnest money back?
The short answer is: yes – for most cases. Earnest money is not given to the seller’s side unless the buyer’s offer to purchase is accepted. At that time, the earnest money can be paid by check, or more often than not, an electronic transfer process can be made. This was a change implemented since the onset of COVID-19.
There is another consideration for whether or not, and when a refund of earnest money would take place. We’re talking about contingencies.
If the sale falls through due to appraisals or inspections; as long as the contract allows for those contingencies, you should get a full refund of these funds.
Remember, the earnest money being held by a third party, so in order to ensure the return of earnest money following a rejection, the contract should cover (minimum) the following three contingencies:
- Inability to land financing – The buyer may have difficulty with financing, even if it something outside their control, such as a sudden ownership change at their lender.
- Inspection findings – The inspector might reveal that the home requires a new roof or needs other major structural repairs. If the two sides cannot arrive at terms on making fixes, the deal could evaporate.
- Appraisal failure – If the appraiser values the home at $280,000 and the offer is for $300,000, the person making the offer will want to be able to try to renegotiate with the seller or cancel and get their deposit back.
Trusted guidance when you need it most
Getting a trusted professional at your side is essential to navigating the sale or purchase of a home.
The Homes By Ash team has been helping home buyers and sellers achieve their individual real estate goals since 2002.
Contact our team to help you get started on a plan for real estate success today.
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Lisa Ash,
REALTOR®, CRS, CDPE, SRES
Homes By Ash Real Estate Team
Keller Williams Realty Integrity NW
PH: 612.701.8368
EM: Lisa@HomesByAsh.com
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