What is Escrow and Earnest Money
What is escrow?
Escrow is a financial agreement in which a third party, such as an attorney or another settlement or title agent, controls payments between the buyer and seller, only releasing the funds involved when all the terms of the contract are met. As the buyer, once you close on the home, the money you’ve placed in escrow will often be applied toward your down payment and other closing costs. Other costs that can be covered by funds in an escrow account include property taxes and insurance premiums.
What is “earnest money?”
Also known as a “good faith deposit,” an earnest money deposit is paid by a homebuyer to show their interest is legitimate and they intend to close on a home. This may be a percentage of the purchase price or a set amount. To protect the funds, earnest money will be held securely in an escrow account until closing or any disputes are resolved. An escrow account is often set up by your lender with a third party such as a bank, title company, escrow agent, or mortgage servicer. During this time, the buyer and seller will be unable to access the funds. Importantly, earnest money is NOT the same as a down payment, which is the money you put toward the home’s purchase price.
What happens to the earnest money deposit if the transaction is canceled or interrupted?
If the seller stops the sale, the funds in escrow are returned to the buyer. Additionally, if contingencies included in the purchase contract—such as a home inspection, appraisal, or financing, are unable to be resolved—then the money gets refunded to the buyer. However, if the buyer interrupts the sale for other reasons, the seller may get to keep the money. For example, if a buyer waives contingencies prematurely, fails to meet set deadlines, or gets cold feet and abandons the transaction, among other circumstances, this could result in the loss of their earnest money deposit.
How much earnest money should I offer?
Earnest money deposits can be any amount, but typically range from 1% to 10% of the home’s purchase price. The size of your deposit may depend on several factors, including the competitiveness of the market, your down payment amount, whether you include contingencies in your offer, and the seller’s preferences. Fixed earnest money amounts rather than percentages of the home’s sale price are also becoming more common in some regions.
