It is a deposit paid toward the purchase of a home, to illustrate to the seller how serious you are about buying the property.
Why Are They Needed?
Because sellers have a lot on the line when selling their house, they want to ensure buyers are serious when making an offer to buy. The exercise of putting a cash deposit down shows them exactly that.
The bottom line: Earnest money deposits are meant to discourage buyers from just making multiple offers on many different properties, only to “weigh their options.”
If you consider this concept from the seller’s perspective it makes a lot of sense. When a buyer and seller agree on a certain purchase price for a home, the property is usually taken off the market (formally or informally). When this happens, the seller stops accepting and considering offers from other potential buyers. Imagine if you were selling your house, and you took it off the market for a couple of weeks only to find out that the buyer had “played you” by doing the same thing with three other properties! Inconvenience is an understatement, not to mention the money and other prospective buyers that could have been lost.
The earnest money deposit allows the buyer to show the seller “I truly want to purchase this home and am not looking to waste anyone’s time.”
Without the earnest money being paid, a would-be home buyer could essentially take multiple homes off the market, by making multiple offers. This means that several of the homeowners are going through the motions for no reason whatsoever, and with no hope of a sale. These days, sellers rarely accept offers without deposits. So if you want yours to be accepted, you’ll have to pledge earnest money to some degree. The question is, how much?
What’s a Typical Amount to Pay When Buying a House?
Let’s revisit the question at hand: How much earnest money should you pay toward the purchase of a house? There are no hard-and-fast rules about these deposits. They vary from one housing market to the next, based on several factors. Most often the activity level within the local market dictates the earnest-money trends.
The amounts really vary but some real estate agents say that 1% – 2% is a good rule of thumb. In a slower market, where sale properties are sitting idle with very few offers, you might get by with an earnest money deposit of $500 – $1,000. In a higher-end market, and/or one with a lot of competition from other buyers, you might have to pay 2% – 3% of the offer amount.
Your agent, if you have one, should serve as a great source of counsel regarding the average for your area and price range. Ask your agent how much of an earnest money deposit you should pay, for the type of property you seek. Stick to the local norm in order to avoid losing the home to a stronger buyer/offer. If you try to make a deposit that is well below average for your area (and below what the homeowner is expecting), they might not take you seriously.
Unless you back out, you don’t lose the deposit because it goes toward the purchase price if the deal goes through. That’s the whole point — to show the seller you’re sincere and earnest about purchasing the property. A buyer pulling out at the last minute is a seller’s worst nightmare so the forfeited deposit compensates them for dealing with this disappointing setback.