If you’re looking to buy a home or a commercial property, you’ll likely come across the term Earnest Money Deposit. This deposit is made to the seller to demonstrate your serious intent to purchase the property.

This article will tell you everything you need to know about the concept, including the meaning of earnest money, its conditions, and its benefits. Prior knowledge of earnest money will help you make informed decisions regarding deposits and sale agreements when purchasing a property.

Earnest Money Definition

In high-value real estate transactions, the seller typically needs some assurance from the buyer of their intent to purchase before drafting a sale agreement and completing other formalities. This assurance is usually provided in the form of earnest money. Also known as a good faith deposit, earnest money is defined as a small deposit the buyer makes to the seller upon confirming the purchase of a property.

Once deposited, these funds are generally held in an escrow account till the sale is finalised. It either gets adjusted as the purchase cost at the time of sale or is refunded, as per the agreed terms, in case the sale isn’t realised.

How Does Earnest Money Work?

Here’s how earnest money generally works:

• The buyer expresses their intent to purchase the property.
• After negotiations on the purchase price, the buyer and seller decide upon the percentage of earnest money.
• The buyer makes the earnest money deposit.
• The seller finalises a sale agreement and the earnest money is adjusted against the purchase price.

For example, if a buyer has agreed to purchase a property worth INR 10 lakhs, the seller might request a 1% deposit as earnest money. This means the buyer would pay INR 10,000 as earnest money to demonstrate their intent to purchase. Post-deposit, the contract is finalised and signed.

The contract should also outline the terms and conditions for the refund of earnest money. This ensures that if circumstances change, the buyer has the option to back out of the sale and recover their deposit according to the agreed-upon terms.

Importance of Earnest Money Deposit

An earnest money deposit is essential to make sure the purchase goes smoothly for both parties. Here’s why it is important:

Show of Good Faith

Show of Good Faith: When the buyer makes the earnest money deposit, it demonstrates their good faith and sincerity in purchasing the property. This assurance helps sellers, especially if they have multiple offers, to feel confident in the buyer's commitment. It also assures the buyer that the seller is dedicated to moving forward with their offer.

Part of the Down Payment

The earnest money deposit is generally considered part of the final down payment due at the time of closing. This reduces the overall amount the buyer needs to pay at once, making the purchase more manageable.

Held in an Escrow Account

Earnest money deposits are typically held in an escrow account, which is a neutral, third-party account managed by a title company or real estate agent. This ensures that the funds cannot be accessed or withdrawn by either party until the deal is finalised, providing security for both the buyer and seller.

Benefits of Earnest Money Deposit

There are several benefits to making an earnest money deposit, such as:

Offers a Buffer Period

An earnest money deposit provides the buyer with additional time to arrange the necessary funds for the purchase without the risk of losing the property.

Increases Offer Credibility

In situations where multiple buyers are interested in a property, an earnest money deposit enhances the credibility of the buyer's offer. It demonstrates sincerity and seriousness, making the buyer's proposal more attractive to the seller.

Conditions for Earnest Money Refunds

The conditions for earnest money refunds should be clearly outlined in the purchase contract. Here are some conditions buyers can negotiate regarding earnest money refunds:

• If a home inspection reveals significant issues with the property, the buyer may negotiate for repairs or choose to back out of the sale.
• If the home appraisal comes in lower than the agreed-upon purchase price, the buyer can negotiate a reduced price or opt to withdraw from the purchase.

Additionally, with the seller's agreement, the buyer may include conditions such as:

• If the buyer is unable to sell their current property.
• If the buyer is unable to arrange the funds required for the purchase.

How Do You Protect Earnest Money?

While depositing the earnest money shows the good faith of the buyer towards the seller, it often comes with a risk of the seller backing out of the deal. Here are some ways buyers can protect their earnest money:

• Get the contract terms in writing to eliminate any room for disputes. Any change in the finalised contract must be agreed upon by both parties.
• The contract must include contingencies for inspections. Ideally, it would help the buyer if there are contingencies for financing as well.
• Deposit the funds in an escrow account with a credible third party. This ensures that the buyer and seller will only be able to withdraw the amount as per the terms of the contract.

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Conclusion

If you’ve found your dream home, property, or investment project, offering an earnest money deposit to the seller demonstrates your sincerity in purchasing the property. This deposit also provides you with some buffer time to arrange the necessary funds.

To further support your purchase, consider opting for a home loan. SMFG Grihashakti offers home loans of up to 90%* of the property’s value at competitive interest rates, with flexible repayment tenures of up to 30 years. Check the documentation required and apply online today to bring your dream property closer within reach