Who is Earnest and What is Escrow... and Why Do They need My Money?

Posted by Key2See Team on September 22, 2021

Who is Earnest and What is Escrow... and Why Do They need My Money?

There are terms often thrown about in real estate with the assumption that they are part of everyday conversation… not the case!  Especially for first-time homebuyers, and those who have been through the process but could use a refresher!  I often gently remind Jenn, not everyone has been in the real estate business for 20 years... that's where I come in, putting the real in Realtor!

Meet Escrow. In the buying and selling process, you'll come across this word on multiple occasions. What is escrow? What does it mean, and how does it relate to the real estate transaction? Read on to find out more.

Escrow is a bond, deed, or other money document kept in the custody of a third party, taking effect only when a specified condition has been fulfilled. Escrow isn't just a term in real estate, either! Escrow or escrow agent is, at the base, a middleman for two parties in a large transaction. They hold onto the money until all conditions are met. 

The first time you may hear escrow in the buying and selling process is when you make an offer on a home. An earnest money deposit, EMD, (money to show the seller you are a serious buyer) is given to a usually neutral and impartial, third-party (typically the designated title company) to hold throughout the process of the sale. Your money is now in escrow. This is an important step for the safety of you and your money. If you did not have a third-party holding onto your earnest money deposit, what would happen if the contract fell through and the seller still had a hold of your earnest money? You wouldn't be as protected as you are with a neutral third-party holder, often known as the closing agent.

Where does the money go once it leaves your hands? If the buyer backs out of the home purchase and conditions of the contract are not met, the seller will receive the earnest money deposit that the buyer deposited. If the seller backs out of the home purchase under conditions not met or if something is wrong on the property that had not been disclosed (ie: something was uncovered during home inspection), the buyer will receive the earnest money back that they deposited. If the home sale is completed, the money is transferred to the seller. 

Meet Earnest. When you are buying a home, the financial verbiage can get a little (make that a lot) confusing. You have heard of earnest money deposits and down payments, but do you need one over the other? Do you need to accommodate for both? Are they the same thing?

Both earnest money deposits and down payments are critical parts of the home buying process, but they are definitely not the same thing. However, in both cases, the more money you can offer, the better your chances may be of getting the home you want. So, what is the difference? Here you have it…

What exactly is an earnest money deposit (EMD) you ask…To show a seller that an offer is serious and made in good faith, a prospective homebuyer will include a check with their offer, for typically 1-2% of the purchase price. This is known as the “earnest money deposit” and is an important part of a buyer’s offer. The seller may get to keep that money if the buyer pulls out of the deal for a reason that isn’t allowed under the purchase contract, such as the buyer simply changing their mind after the contract is mutually agreed upon. A strong earnest money deposit essentially acts as security and incentivizes the seller to accept an offer and take the home off the market versus waiting for offers from additional prospective buyers.

 If the seller has several offers, a larger earnest money deposit could set you apart from the competition! For more expensive properties, your real estate agent might be able to negotiate a lower deposit. As a general rule, earnest money is worth as little as a seller is willing to accept and as much as a buyer is willing to offer.

Always make sure you have the money in the bank before you submit a check with your offer. The earnest money deposit is typically turned over to the title company after the contract is mutually agreed upon, 3 days to be exact (unless otherwise decided upon) The money is placed in an escrow account until closing. If the deal goes as planned, the earnest money is usually applied towards your down payment, and/or closing costs.  When first explaining earnest money I’ve seen a bit of panic on some faces… this is not money in additional to your offer, it comes off the top at closing in one way or another!

In the event the contract becomes null and void based on one of the contingencies in your offer, such as the results of the home inspection, your earnest money deposit will usually be returned. But, of course you need to make sure you read your refund agreements carefully… ask your agent!

Here comes the down payment, something more widely understood.  The down payment is the amount of money that the lender requires you to put towards the purchase of the property. Normally based on a percentage of the total sales price, the amount is typically established early in the loan application process with your lender. While down payment amounts can vary from 0% for some first-time home buyers and VA loans or 3.5% for an FHA loan to upwards of 20% + for certain conventional loans, normally the source of the money must be verified and approved by the lender.

With a higher down payment, your chances of getting approved for a mortgage are higher. In addition, you will have a smaller monthly mortgage payment and more equity in your new home.

Simply put… Your EMD is money offered to the home seller to convince them you are committed to purchasing their home. A down payment is the amount of money the buyer must produce for the lender to approve the loan on the home. In its simplest form, the earnest money deposit is a promise to the home seller, and a down payment is a promise to the lender.

Find the right agent and let them help you with the rest... you know where to reach us!