Understanding Earnest Money for Home Sellers
Back in July, we discussed the concept of earnest money from a home buyer’s perspective. But the game changes a little bit when you’re in the seller’s shoes.
Whether you are a first-time home seller or you’re on house number three, understanding how earnest money works can help protect you while finalizing the deal.
Essentially, earnest money is used for the buyer to express their intent on buying a home and to provide the legal consideration for the contract to be binding. After striking a preliminary deal, but prior to completing final paperwork, the prospective home buyer will send the seller (usually the seller’s attorney or real estate broker) the defined amount as specified in the contract.
Because of the legality, this is done to protect the buyer from the seller striking another deal while simultaneously protecting the seller from the buyer backing out of the home purchase.
There is no set equation for the amount of earnest money, so as the seller, it is really up to your discretion. Typically, the price is less than a down payment, but 1%-3% of the purchase price is common.
It should be high enough so that the buyer will not walk away from the transaction, but not so high as to kill the deal. In hot markets, the amount of earnest money can steepen, often becoming negotiation collateral between the seller and competing buyers.
As the seller, you should obviously be aware of the local market and any competition. This should certainly play a role in your determination. And, at the end of the day, good communication by the buyer’s and seller’s side should enable you to settle on a reasonable price for your protection.
Ultimately, the seller’s side is responsible for establishing an escrow account for the money to remain until the deal is finalized. Your company, if you are a broker, should have a process streamlined, otherwise there are other third-party escrow options. Assuming you have a real estate attorney assisting with the closing, he or she can also lend a hand in the setup process.
Although the earnest money will eventually reach your hands, it should not do so until the deal is finalized as a credit towards the purchase price on the closing statement and often going towards the broker’s commission. Again, earnest money is protection for both the home seller AND the home buyer.
Most transactions go smoothly, but it is important to prepare if things go awry. Here are some steps you can take as the home seller.
Know your deadlines. It is best practice to stick to your deadlines. When buyers try to push deadlines back repeatedly, sticking to your deadlines ensures that you have a serious buyer. There are always reasons for extensions, but they should be reviewed carefully.
Know your contingencies. Typically, sellers will want to limit the contingencies and buyers will want to maximize the contingencies when closing on a home. Common contingencies concern home inspection issues, title issues, or appraisal issues. Removing contingencies might mean you have to lower the earnest money amount, so keep that in mind.
Know your property. The best way to avoid contingency issues is to know your property ahead of time. Your attorney should know the condition of title and know how to resolve any title issues. Working with one of the many excellent brokers throughout Illinois in regards to pricing and knowledge of neighboring properties goes a long way in securing that you’re able to meet deadlines.
Cash the earnest money. Oftentimes, the earnest money is delivered as a check to the third-party escrow entity. When possible, encourage the escrow entity to deposit the check into the escrow account quickly to avoid any clearing issues.
Communicate well. Most importantly, real estate transactions can and should go smoothly if both parties and their attorneys communicate well and remember that both sides of the transaction want the same thing. Buying and selling real estate can be a very stressful time. A good attorney and broker can remove a lot of that stress and help make the transaction much smoother.
Whether you’re buying or selling a home, handling earnest money in an ethical manner can go a long way in demonstrating good will towards the other party. For help with managing earnest money and other aspects of the residential closing process, schedule an appointment with Lee Scott Perres, P.C.
