In this intense seller’s market, buyers are pulling out the stops in order to compete. For some, that may mean offering over list price, waiving inspection, or offering other incentives to the seller. Two of the most common incentives are earnest money and non-refundable deposits. These incentives help to show a seller that a buyer is serious, but they do have some risks for buyers. Here are four things you should know about earnest money and deposits before you sign the contract!
Earnest Money & Deposits Are Credits At Closing
Earnest money is a deposit that represents a buyer’s good faith in entering into an offer to purchase a property. While buyers must pay earnest money and deposits before closing, they are both considered credits to the buyer at closing. Desiree Kumar, a licensed attorney with AMT Law Group in Illinois and a former real estate agent, reminds buyers, “Both deposits and earnest money deposits function similarly and are both typically credited at closing.” How the earnest money or deposit is credited is typically at the discretion of the lender, so buyers should communicate with their loan officer to determine how those funds will be credited.
You Might Not Get The Money Back
If you’re asking yourself, “Is earnest money refundable?”—you aren’t alone. According to Kumar, the most misunderstood aspect of deposits and earnest money is “that they are always refundable.” This misunderstanding can lead to an unpleasant financial situation and even litigation if a buyer terminates a contract. Kumar says “earnest money provisions have a propensity for litigation,” however, depending on how the contract is written, earnest money can be refundable. To determine if your earnest money is refundable, Kumar advises “The executed offer will dictate what happens to the earnest money upon termination of the contract. It is important to understand what the offer says before signing it.”
Tip: It is possible for sellers to negotiate for earnest money to become non-refundable after inspection. If buyers are looking for ways to strengthen their offer, they might consider this option.
Non-refundable deposits, common with new construction, differ from earnest money. “Deposits generally benefit the seller,” says Kumar. And in this market of rising building costs, builders prefer buyers to pay a deposit. In most cases, unlike with earnest money, these deposits are not refundable to the buyer if they terminate. However, Kumar reminds buyers “Depending upon the reason for termination, the deposit may still be refundable.” But she would advise buyers considering a non-refundable deposit to remember “that no matter the reason, they cannot get their deposit back, even if the sale does not go through.”
Tip: Buyers have the right to have an attorney review a contract before signing it. Fully understanding the legal wording and ramifications of a termination is critical to avoid any future litigation.
How The Money Is Accessed Varies
Both types of pre-payments are handled differently when it comes to who has access to the funds. For example, earnest money is held by a 3rd party until closing or termination. In most cases, earnest money funds are typically held in escrow until closing, meaning sellers can’t access those funds until closing. Earnest money funds can be held by the real estate brokerage, the title company, closing attorney or other 3rd party.
Deposits, on the other hand, can vary. Depending upon how the contract is written, deposits can be spent immediately by the seller and may not have to be held in escrow. Even if the funds are immediately accessible by the seller, if the buyer does close then they still receive a credit at closing.
Tip: Non-refundable deposits typically benefit the seller and are another way to make an offer stand out among multiple offers; however, buyers should be aware of the risks involved before agreeing to a deposit.
One Benefits The Seller and One Benefits The Buyer
Non-refundable deposits tend to benefit the seller, since (in most cases) these deposits are not refundable to the buyer. The amount of the deposit can be determined by the buyer, the seller, or negotiated between the two. While sellers like the appeal of non-refundable deposits, Kumar states she “very rarely advise[s] a buyer to enter into an offer with a non-refundable deposit.” The risk with a non-refundable deposit is that the buyer could lose the money if they fail to close.
Earnest money, on the other hand, can benefit the buyer. Again, depending on how the contract is written, that “good faith” can be refundable to the buyer if they fail to close. If sellers are wanting a guaranteed payment should the buyer fail to close, a non-refundable deposit may be the best option for them; however, it’s important both sides understand what happens to the funds upon termination and what can legally be done with the funds prior to termination or closing.
Work With an Agent!
In this intense market, buyers are desperately searching for ways to make their offer stand out. By strategically structuring an offer with benefits to the seller, this can help a buyer’s offer to standout. It’s important to know which type of pre-payment offers the most benefits and least risk. The best way to safely navigate the current real estate market is to utilize the services of an experienced real estate agent. You can find an agent in your area by using Homes.com agent search tool!