Understanding FHA Earnest Money Deposits

Earnest money graphicThe Federal Housing Administration (FHA) was created in 1934 to help low-income individuals and families purchase homes. The FHA insures the mortgages and makes the loans available to borrowers with low credit scores.

The loan program has been around since then and is still going strong. The FHA has strict requirements for eligibility and a high approval rate. The FHA mortgage loan program offers great benefits to both the lender and the borrower.

What Is Earnest Money in Real Estate?

Earnest money is a type of down payment that is used in real estate deals. When a person wants to buy a house in the United States, they put down a deposit called “earnest money.” All the terms of the sale have to be met in order for the earnest money to be released.

How much is the earnest money?

Your earnest money will either be a fixed amount or a percentage of the purchase price, depending on the customs of the real estate market in your area.

There is no established minimum amount for an earnest money deposit. However, it is normally between 1% and 5% of the entire purchase price. This may vary dependent on the local market, so consult a local real estate agent for an estimate.

It is likely that the amount of earnest money necessary for the purchase of a newly built home will be more than that required for the purchase of an existing property.

When there is intense competition in the real estate market, sellers may want a larger than usual deposit from potential buyers. If potential buyers want to gain an edge over other bidders, they might show their seriousness and financial stability by giving a bigger than usual sum of earnest money.

The importance of an earnest money deposit

Typically, home sellers want a good faith deposit. It protects both the seller and the buyer's interests. It demonstrates to the seller that you are serious about purchasing the property, which might be comforting if they agree to remove the home from the market pending the appraisal and inspection findings.

When purchasing a home that is in great demand, a substantial down payment might convince the seller to choose your offer above others. You may also negotiate more advantageous contract conditions.

How to Get an Earnest Money Deposit Back

If the seller accepts your offer, your earnest money deposit will then pass to a third party until settlement. During the duration of the contract, the earnest money may be kept in escrow by a title firm, attorney, bank, or broker, depending on the terms of the agreement. 

How you get the money back depends on your offer and the conditions of your real estate contract. Most home buyers ask the seller for “contingencies” to protect their earnest money and avoid a lawsuit for failing to complete the sale. Common contingencies include:

  • Appraisal contingency: You will be unable to continue the sale if the appraisal comes in at a lower value than the selling price.
  • Mortgage contingency: The mortgage contingency allows you a way out if you can't acquire financing.
  • Home inspection contingency: In the event that the house inspection uncovers problems and the seller is unwilling to make the necessary repairs, the sales agreement between you and the seller will be terminated.
  • Home sale contingency: The home sale contingency gives the buyer(s) of the home the option to back out of the agreement if they are unable to sell their current residence.
  • Other common contingencies include water purity and flow, and septic system, and pest.

Contingency Agreements and Earnest Money

Contingency agreements are popular among real estate brokers because they are put into the sales contract to protect the home buyer and seller in the event that specific conditions are not satisfied.

Agreements that contain contingency clause(s) often require the seller to refund the deposit to the buyer within a particular time frame if any contingency is not satisfied.

You can lose your earnest money if you're not careful!

Caution signThere are various ways for prospective purchasers to safeguard their earnest money deposits.

Ensure that the contract covers finance and inspection contingencies. Otherwise, the deposit may be lost if the buyer is unable to get financing or if a significant problem is discovered during the home inspection.

Read, comprehend, and abide by the contract's provisions. For instance, if the contract stipulates that the home inspection must be completed by a specific date, the buyer must adhere to this date or risk losing the deposit and the property.

Make sure that the deposit is properly handled. The deposit should be payable to a trustworthy third party, such as a respected real estate agency, escrow business, title company, or law firm (never give the deposit directly to the seller). Always receive a receipt and check that the monies will be kept in an escrow account.

Final Words: What to Remember

In conclusion, an earnest money deposit will help you establish your position as a serious buyer before other home buyers, and is a common part of the home buying process.

Earnest money is a deposit made to a seller to prove that the buyer is serious about purchasing the property. It is typically 1-3% of the purchase price. FHA loans are government-backed mortgages that are available to buyers with low credit scores. The minimum down payment for an FHA loan is 3.5%.

SOURCE: Section B. Acceptable Sources of Borrower Funds

Recommended Reading

  1. Do you need a cosigner for an FHA loan? 3 things to consider.
  2. FHA Loan Credit Requirements: Everything You Need to Know
  3. FHA Debt-to-Income Ratio: Everything You Need to Know