What is the difference between escrow and earnest money? These are financial terms that are very important to know when involved in a real-estate deal.
Escrow is a transaction that involves both the seller and the buyer. In an escrow transaction, funds are deposited by the buyer in an account designated by the seller. The funds are released to the seller only after all agreement terms have been met.
Earnest money on the other hand is usually given as a down payment on a property. It is a deposit given by a buyer to a seller before they enter into an agreement. Keep reading this article to know more about what these two terms mean and how they will impact your real-estate deal.
Is My Earnest Money Deposit Refundable?
In most cases, earnest money is not refundable. However, the buyer should always check the terms of his or her offer to purchase before making a payment to ensure that it will be returned in certain circumstances.
The earnest money deposit may also specify if and when it will be refunded. If the offer to purchase is terminated, it may specify that all or part of the earnest money will be refunded.
The most common reason for a buyer's earnest money not being returned is the failure to close the transaction on time. There are often contingencies in an offer requiring certain actions by either party before closing (e.g., obtaining financing). If these actions are not completed to the satisfaction of both parties, the offer may terminate and any money paid towards it will be forfeited. Even if a contingency is waived by the buyers, it does not always mean that they get their earnest money back. Ask your real estate agent if you have any specific questions about your contract.
What Is A Good Faith Deposit?
"Good confidence deposits" can sometimes be interchangeable with the words "earnest deposit." While earnings are directly offered to buyers, an honest deposit is paid in the same direction to show commitment to move forward in the mortgage-related process. Your deposit will cover things that require an appraisal of your loan, including:
How Much Money Should A Homebuyer Pay?
This depends upon the market and the conditions. When looking at a place where the bids and offers are intense, you might need to offer a considerable amount. Alternatively, lower-income deposits might be good for fixers in slower e-commerce markets. In many real estate markets, the median good faith deposits range from 1-22% of the purchase price. The maximum is sometimes reached when a property has more than one prospective buyer. Certain sellers also prefer to set a sum to avoid buyers that are not serious.
How Is Earnest Money Used?
All states have strict laws about managing the deposits before the transaction closes. Most of the cash is held by escrow accounts that manage real estate agents and title companies. The money deposited in the bank will be added to your closing costs and returned to the buyer after the transaction. A good contract, supplemented with earnest money deposits, shows the seller that your money is in good hands.
What Happens To Earnest Money After Closing?
It's important to understand what happens to your earnest money and how it can be released back to you if necessary.
Escrow agents handle the proceeds from home sales differently depending on local custom and their own preferences. However, there are several common practices; here are typical scenarios for three different states: California, New York and Texas.
escrow firm. Proceeds from the sale are also deposited in this account and remain there until closing, when they are disbursed to all parties as appropriate. Earnest money can be released back to you during escrow if your purchase contract permits it. For example, many contracts provide that you have the option to back out of the deal for any reason prior to closing by getting all or part of your deposit back. Buyers sometimes use this provision simply because they're nervous about buying such an expensive item without being able to look at it first.
New York State
Earnest money is deposited into an escrow account and generally remains there until closing. However, the standard deposit varies depending on whether or not you're using a licensed real estate broker (they typically collect around 2 percent of the sales price), and how much time has passed since your offer was accepted (earlier offers usually require more down payment). Earnest money can be released back to you during escrow if there's a problem with your purchase contract - for example, if there is a failed inspection - but this option isn't routinely provided for in contracts here. It’s up to your closing agent whether they choose to allow this type of release.
Most earnest money simply goes into a "trust" account at the title company or escrow firm where your purchase contract is being handled. At closing, this money is applied toward any fees due to the agent who brought you the deal, but only if the home sale closes as scheduled - otherwise it's returned to you.
In some states, local custom dictates that earnest money be refundable, no matter what language may appear in your purchase agreement. In others, contractual provisions can supersede these rules and make your deposit non-refundable unless certain conditions are met - such as cancellation of the transaction by mutual agreement of buyer and seller. Research the rules and regulations of your state to be sure of how this will be applicable to you.
Paying Earnest Money Deposit
Usually, you pay earnings in escrow accounts or trusts under the management or control of a third party. Accepted payments are personal checks, certified checks or wire transfers. The money is retained in the bank's escrow account until a sale is completed. When you are budgeting to purchase a house and saving money for closing costs and other deposits, keep money aside for an earnest deposit.
What Are The Benefits Of Escrow?
Escrow is a financial transaction that involves the transfer of money or other assets from one party to two others. It is used in different circumstances, such as when buying a house, when selling an item online, and when transferring funds between bank accounts.
The benefits of escrow include:
What Are The Drawbacks Of Escrow?
While escrow is a very useful service, there are some disadvantages. For one, the escrow system requires the trust of third parties (in this case, the escrow provider). This may be mitigated by finding an honest and trustworthy escrow provider; however, it can make people uncomfortable trusting an anonymous person with their money. Additionally, when using an automated system for holding money when purchasing, there are fees involved which reduce the amount that you have when you are ready to purchase your item.
The fees are typically between 1-2% of the total cost of the item being purchased. As well as these two problems comes uncertainty within transaction times. Escrows must be manually carried out in most cases so waiting to make sure both parties are satisfied can take much longer than expected. Additionally, there is not always full transparency which may lead to disputes over what was agreed upon during the transaction.
What Are The Benefits Of Earnest Money?
The earnest money is a payment given by the buyer to the seller for goods that are yet to be delivered. The buyer is said to be "earning" their earnest money when they are confident that they will receive the goods at the agreed-upon time and place. The buyer can use their earnest money in case of a dispute with the seller. If there is a dispute, then the buyer can take legal action against the seller and ask for the return of their earnest money. In some cases, if there is no dispute, then both parties can agree on how much of their money should be returned after the delivery of goods or services.
The time it takes to close a real estate transaction using earnest money depends on the type of property, the location, and the buyer's financial situation. It usually takes about two weeks for a residential sale to close. For commercial transactions, it typically takes about six weeks. In general, buyers in a hurry should look for properties that are listed for sale with immediate possession or are under contract within two weeks. If you want to buy an investment property that is listed with an agent and has been on the market for more than two months, you should expect to pay more in earnest money.
What Are The Drawbacks Of Earnest Money?
When it comes to the drawbacks of earnest money, the biggest one is that this money is usually held in escrow until the sales contract is finalized. If the buyer backs out of the deal, they are required to return all or part of the earnest money depending on how much was given up front as well as what they have done with it during that time period. If they don't return it in full, then they will owe more than what was originally given up front which can lead to legal issues and penalties.
Conclusion: Escrow vs Earnest Money?
To simplify it, earnest money is a deposit that a buyer makes to a seller as a sign of good faith and intention to complete the sale. The earnest money serves as down payment on the home, but it does not go toward the purchase price. In other words, if your earnest money were $10,000, you would only need to finance $290,000 at closing (not $300,000). If you can afford more than 10 percent for an earnest money deposit, that's usually better because your down payment will be bigger. The catch: You lose that extra cash if you walk away from the deal before the settlement date.
Escrow is a third party whose responsibility is to ensure that both parties live their end of the transaction. The roles of the escrow officer are to make sure the proper documents are signed by all parties involved, receive funds, disburse money according to instructions provided by law or company policy, and notify other parties when transactions have been completed.
The main difference between earnest money and escrow is that with escrow you are taking an extra step in making sure your interests are protected during the sale process. With an earnest money deposit, there is no third party protection for either buyer or seller should one of them cancel or fail to complete the sale after having received that deposit.
If you do choose earnest money over escrow, be aware that this means you will not have any protection if something goes wrong. There are benefits and drawbacks to both so do your research and talk to your real estate agent to find out what is the best option for you.
Keep reading on SmartRealEstateNerd.com: Want to learn more about escrow and its related topics? Check out this post on Escrow vs Principal for more information.