Why is earnest money important in a real estate purchase?

An earnest money deposit submitted with an offer to purchase real estate might seem like a simple matter. In fact it's a very important statement. For many buyers the only real concern is to make the deposit for as little as possible and to make sure they can get it back. But to sellers of real estate an earnest money check represents an intangible. It represents commitment. When the time comes to give the Realtor the earnest money deposit check people often begin to squirm. When asked "how much should I make the check out for" they seldom agree with the answer. Why? Because they only see the check as a way to lose money. In fact, it's a way to guarantee a purchase.

Think about the average buyer making an offer on a condo. Of course they want to buy the condo for as little as possible. No problem there. The Realtor representing the buyer should be trying to achieve that very goal. So the buyer assumes something like $100 or $500 should be OK. Not OK. Here we have a lack of commitment. There's no real 'skin in the game'. My rule is 2% of the offer price.

Back to the condo buyer . For a condo on which we're offering $300,000 against an asking price of $425,000 a check for $500 is not realistic. We should be submitting a check for $3000.

Buyers should realize that a seller who accepts your offer to purchase is taking their property off of the active market. The seller is taking the risk that a better buyer might come along while the property is tied up in a contract. A better buyer who is willing to pay more, pay in cash and eliminate the possibility of the deal falling apart due to financing or both.

The seller wants to make sure you aren't going to back out of the purchase. The best way to do that is to have your commitment. Nothing says 'commitment' in a real estate transaction like money. You've got to have something to lose that makes the idea of walking away from the transaction out of the question. The only thing with that kind of power is money. Your money. At risk.

Now, we're not talking about transactions which don't close because of something beyond your control. If the financing has been addressed properly in the contract and you can't obtain financing to close the transaction your earnest money will be returned to you happily. If the home burns to the ground before closing or the termite inspection discovers a termite problem you won't have any trouble getting all of your money back. In fact, if the contract was constructed correctly there's virtually no chance you'll lose your earnest money deposit. If you don't feel confident that your Realtor will protect your money you should find another Realtor.

By the way, earnest money is one of the most common problems that occur when people buy property from a seller directly without a Realtor to protect the buyer's interest. The buyer or the seller (usually both) are not educated as to how to make a contract that protects both of their interests. In the event the transaction doesn't close the seller often keeps the earnest money and the buyer doesn't have any protection.

But, if you decide a week before closing that you can't afford the home or would rather buy something else, you're going to lose your escrow deposit. As you should. In a case like this you're making a decision not to abide by the contract you signed and you have no recourse to your earnest money. There's a very simple way to avoid this problem. Don't ever make an offer to buy a property if you're not 100% serious about buying it.

When I act as a seller's agent and receive an offer to purchase with an inappropriate earnest money deposit I recommend to the seller that the contract be returned requiring more money. The seller will usually accept this recommendation. If the buyer refuses to put more of his money into the deposit my sellers will usually reject the offer. Why? Experience has shown people who don't make a 'good faith' earnest money deposit don't close deals. 'Good faith' here means an escrow deposit of 2% of the offer price or more.

If you are dealing with an ethical Realtor who is acting as your agent in the purchase of real estate your money will be protected. Consider his or her advice. If you're unsure about the agent contact the state real estate oversight commission and the local Realtor association. Both will be happy to tell you if the Realtor is reputable. A special note here about those real estate agents who work 'on-site' in the models of home builders. You should know that they represent the seller. No matter how nice they are they are employed by the seller/builder and are obligated to look after his interests, not yours. Some of them will be willing to accept designated agency in your transaction. If they will not you should get a Realtor from a general brokerage to represent you in the purchase.