Earnest money. It’s the portion of the down payment that the buyer puts forth when they go under contract on a property. It’s usually held by the title or escrow company from the time of contract until the closing. Is it really that important? Oh yes, it is.
Why is the earnest money so important?
I’ll illustrate with this real-life story. My seller listed their house recently. The house received several showings and two offers the first day on the market. The seller chose the very-close-to-asking cash offer with no inspection, no appraisal, and a two-week close. The contract price was in the low $500’s, and the buyer put forth $10,000 in earnest money, which was roughly 2% of the purchase price. On the day of closing, just two hours before the closing was scheduled to happen, the buyer terminated the contract. Essentially, they just changed their mind and no longer wanted the house. According to the Colorado Contract to Buy and Sell, the buyer can do that, and the only consequence they faced was the forfeiture of their earnest money.
Here's what happened
For this cash buyer, the loss of $10K was not that painful, and they were able to go find another house. For the seller, however, this loss was much more significant. They thought the house was essentially sold, but instead, they encountered the stigma of being “back on the market”. When a house falls out of contract, many buyers automatically, initially assume that there is something inherently wrong with the house, or else it wouldn’t have fallen out of contract.
For the seller, retaining the $10K helped offset the anguish of having the contract terminated, but the lingering thought in their mind related to the amount of the earnest money – was it high enough or should it have been more to begin with. If the earnest money amount had been higher, would the buyer have thought harder about cancelling the contract?
That thought leads to the discussion about how much earnest money is enough? A seller establishes minimum guidelines when they list their house, and the general rule of thumb is that the earnest money should be an amount low enough so that it’s not a barrier for a buyer writing an offer but high enough that it’s painful if a buyer were to lose it. Depending on price point, it’s usually somewhere in the realm of 1-3% but it should be higher in some situations.
For my seller, the story has a happy ending. After the contract fell, the house went back on the market, we didn’t have to explain and overcome any negative stigma after the first contract fell, showings resumed in full force and we were back under contract the next day. And – no surprise – we commanded a higher earnest money this time around.
Renee Cohen is a Colorado Realtor with a passion for helping her clients find their dream homes in the challenging Denver market. She loves educating her clients about the market, advocating on their behalf, and helping them make informed decisions. Reputable. Reliable. Remarkable. Real Estate. Contact Renee to assist you with your real estate needs!