On the heels of our first-ever Agent Appreciation month, Inman is leaping into February with our Residential Finance theme month. Join us as we investigate how buying and selling a home is changing, from companies backing consumers in new ways to integrated services that handle the entire transaction.
Do you know when the deposit is due when buying a home? Many first-time homebuyers will ask their real estate agent this question and many others, so you must be prepared to give them an accurate answer.
When buyers are purchasing a house, there is a lot to think about and remember. They need to have their financing approved by the lender, and they need money saved to pay the expenses involved in purchasing their new home.
There are many stages agents need to stay on top of in the process. Below, we’ll take a look at what buyers need when purchasing a home and how to talk them through the process.
Why do we need to get pre-approved?
When buyers don’t have the money to purchase a house outright, like the majority of homebuyers, they will need assistance from the lender. Lenders or mortgage companies will need to be given details of the buyer’s income and check their credit history.
The lender will make sure that the buyer has sufficient money available for a deposit and that it comes from an acceptable source. When they have completed their checks, they will be able to let the buyer know how much they are willing to lend.
Agents should have this information at their disposal, which will allow you to narrow down the house-hunting search. Buyers, however, will still need to have other money available for the earnest money deposit and down payment, which won’t be covered by the mortgage.
Proof of funds will be required by the seller, proof that the buyers have mortgage approval and the funds available to pay the other costs involved.
What is earnest money?
Here’s the best way to explain it to buyers:
So that the seller of the house the buyers want to buy can be sure of your intention to purchase, a house deposit is needed. Those in the real estate industry refer to the deposit as your earnest money.
This earnest money deposit commits the buyers to their offer and gives the sellers some protection should the buyer not follow through in purchasing the property.
This deposit needs to be paid around the time of the real estate purchase contract signing. The contract will state when the escrow deposit check or electronic transfer, has to be paid into the account of a third party. This is generally when the seller accepts the contract or soon afterward. The funds are held in an escrow account, typically belonging to either the seller’s real estate brokerage or the title company.
It is possible to negotiate when the buyer has to pay the deposit into escrow, but if you aren’t able to meet this time frame, the contract could be canceled. Depending on the details in the purchase contract, there could instead be penalties for not meeting the payment date.
There are some circumstances where a buyer can still back out of the deal. The purchase contract will generally contain contingencies that allow the buyer to get their earnest money deposit back.
For example, if a severe problem is discovered during the home inspection and an agreement can’t be reached to repair or negotiate the purchase price, a contingency could allow the buyer to have the earnest money returned.
The impartial party will hold the escrow deposit until closing or if a contingency is triggered to release the funds back to the buyer. More often than not, if there is a dispute between the parties regarding the deposit, the seller’s broker will retain such deposit until a decision is made on who shall keep it. Typically, when a deposit dispute cannot be resolved, a court of competent jurisdiction will have the final say.
Real estate brokers are often in the middle of deposit disagreements. Even if a broker has a strong feeling about one party being entitled to a deposit, they cannot release it without proper authorization. One of the differences between a real estate broker and an agent is the enormous responsibility of holding a buyer’s funds until closing.
It’s possible, but not usual, for non-refundable earnest money to be paid. This means a buyer won’t get the deposit back if they need to cancel the agreement for any reason.
A similar situation can happen if a real estate purchase contract doesn’t have any contingencies to allow a buyer to withdraw from the deal. These situations are only likely to take place if the market the buyers are looking to purchase in is very hot.
How much money is needed for the earnest deposit?
The seller will want higher amounts to ensure buyers don’t back out, and in fact, it can help make a stronger offer. However, lower sums of money present less of a risk to the buyer and can make it easier to purchase.
The amount of earnest money deposit will often depend on what is normal locally and can be influenced by how in-demand housing is in the area.
More significant deposits are often required when there are a lot of buyers, and this could go up as high as 10 percent of the purchase price if the property is new construction. Usually, though, the earnest money will range from 1-5 percent of the price.
When you reach closing on the house, the earnest money will be used to pay the buyer’s closing costs or contribute to the purchase price of the home. It is crucial for an agent to be aware of what money the buyer needs to have and when it needs to be paid to keep the deal on track.
This will give you and the buyer a better chance of a smooth and trouble-free purchasing process.
How does earnest money differ from a down payment?
One of the more confusing things for homebuyers is understanding that earnest money deposits and down payment are not the same thing.
The easiest way to explain the difference is that the earnest money is the funds used to lock up the home, and the down payment, on the other hand, is the difference between the purchase price of the house and the amount buyers are mortgaging.
So, if the buyer is purchasing a home for $300,000 and the earnest money agreed to is 5 percent, there would be $15,000 held in the broker’s escrow account. If the buyer is putting 10 percent down to buy the home and financing 90 percent, their down payment amount would be $30,000.
Hopefully, as their trusted agent, you can clearly explain to your clients that their earnest money funds are not the same as their down payment funds.
You should understand that a deposit is an essential part of a real estate transaction. In most real estate sales, without “consideration,” there is no sale. Both buyers and sellers should be informed of the rules surrounding deposit monies, including typical amounts and due dates. Not having solid advice surrounding home deposits could lead to mistakes and financial pain.
As their agent, you have a significant responsibility to educate your clients on how deposits work.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell homes for the past 33-plus years. He has been a top agent with RE/MAX Executive Realty, which serves many towns across the state of Massachusetts. Check out his blog.