Earnest money: what is it?

Put simply, earnest money is money paid to confirm a contract. In the lending industry, earnest money is part of nearly every single real estate purchase contract. Earnest money tells a seller that a buyer is serious and prevents said buyer from making offers on several homes at once and taking them each off the market needlessly. Earnest money stays with the transaction and is applied towards the funds required to close. It can also be refunded if either no additional funds are required to close or if something goes wrong with the transaction.

Typically, an earnest money deposit averages about 1-2 percent of the agreed upon sales price. It’s written by either the real estate broker or a title company involved on the sale side of the transaction and generally deposited within the first week or two into an escrow account to be released on the day of closing.

Here are some common questions I hear regarding earnest money:

How does earnest affect funds at closing?
Consider a purchase price of $225,000 with a buyer putting 5 percent down at closing which is equal to $11,250. This is the amount that is owed the day of closing to complete the transaction. If earnest money was part of the contract equal to 1 percent, the buyer would be bringing $9,000 to closing ($11,250 – $2,250 = $9,000).

When would earnest money be refunded?

This could happen resulting from a couple different situations. First, if a buyer financed 100 percent of the price with either a VA loan, USDA loan, or a down payment assistance program, the loan amount would be equal to the price. The earnest money would have nowhere to be applied to and thus returned to the buyer at closing. Secondly, periodically things happen like a home not passing inspections or a buyer being denied a home loan. Technically, contract language exists which may allow a buyer to be refunded a portion or entire amount of the earnest money even if they’re denied a loan. This should hardly ever happen, however, because the financing bank should have done a pre-approval before the transaction started.

Do mortgage underwriters need documentation regarding earnest money?
If earnest money is part of a purchase contract, it has to be documented, and that’s the short answer. But if you’re still reading this it’s likely because you’re one of those people who likes a deep dive into a subject, so here goes:

You might be asking yourself why a buyer has to document earnest money. Shouldn’t the buyer just have to write a check for it? The simple answer is yes, and the non-simple answer is that it falls within items which must be documented in accordance with underwriting guidelines. These are usually to blame when borrowers become frustrated with loan officers when they ask for numerous documents. However, if a borrower does become frustrated it’s probably because the loan officer is doing a poor job of identifying and explaining needed items in a complete and efficient manner.

Most items related to mortgage underwriting are very straightforward to document. For example:

  • Income – get pay stub copies, W2’s and/or tax returns
  • Insurance proof – have a loan processor call the insurance agent
  • Collateral – order and obtain an appraisal
  • Down payment proof – obtain copies of the asset statements showing the liquid funds

Earnest money has an extra layer of guidelines which, for the most part, don’t create too many issues. These guidelines require both a copy of the actual check as well as proof the check cleared the account from which it was written. This doesn’t sound complicated on the surface, but a wild card in the mix is every bank and bank account having different statement cycle dates. It’s more of a timing complication than anything.

For example:

John and Jenny Housebuyer signed a purchase contract to buy a home with a closing date of November 3, 2016. They wrote an earnest check from their checking account on October 8, 2016. They bank with ABC Bank that produces statements on the seventh day of every month.

Anyone see a challenge with timing? John and Jenny’s earnest check date was written a day after their bank statement cycle date for the previous month. The next statement won’t generate from the bank until November 7, 2016 (a day before closing) and will only show the earnest money clearing the account- a requirement in addition to the check copy. So what can be done? John and Jenny can’t close without proof it cleared their bank and the statements won’t be ready in time.

A good loan officer can sniff this out from the beginning and can properly advise John and Jenny on what to do. In this example, one of them would need to get a 60-day printout of banking activity from the bank capturing their earnest check clearing. Most people can access bank activity online, but you have to ensure all personal identifying information like full names, addresses and account numbers are visible and printed. If not, it will likely require another trip to the bank to obtain a printout with all necessary identifying information listed.

At the end of the day, documenting earnest money isn’t hard, but buyers might be in a tight spot if their loan officer isn’t proactive in detailing what’s required. So if you have a bad loan officer (I hope you don’t, but there are tons of them out there still), just remember to get the following for documenting earnest money:

  • Copy of the check
  • Two months of bank statements from the account it was written
  • 60-day bank printout capturing the earnest check clearing IF bank statement cycle dates don’t line up with target deadlines

Have questions? Call Mike Miles at Fountain Mortgage for more information, or even if you are already working with another bank but need some guidance. We look forward to hearing from you.

June 23, 2020

Mike Miles

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M Squared Financial LLC
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7501 Mission Road, Suite 200
Prairie Village, KS 66208

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