Having significant funds for use as earnest money can increase your ability to secure an agreement for the purchase of property on credit.
Earnest money, sometimes called good faith money, is an amount given by a buyer as a security deposit on a purchase of either real estate or personal property. It is used to show the seller that the buyer is serious about the purchase, and to induce the seller to hold the property for the buyer until financing or full payment can be arranged.
Any payment of earnest money should be memorialized in a written earnest money deposit agreement.
Generally, the buyer wants to put down as little earnest money as possible, and the seller wants the buyer to put down the most possible earnest money. However, if you are the buyer, offering more earnest money than a competing potential buyer can make your offer more enticing.
Real Estate Transactions
In a real estate transaction, the sales contract usually includes a provision for earnest money. In addition to stating the purchase price and down payment requirements, the contract typically provides for a certain amount of earnest money, which will be held in an escrow account until the sale is closed.
The earnest money agreement usually provides that the earnest money will be transferred to the seller upon closing (as part of the down payment), or if the buyer fails to go through with the purchase as required by the terms of the contract. It also usually provides that the earnest money will be returned to the buyer if the buyer is unable to obtain the necessary financing.
If you are the buyer, you should be sure that the purchase agreement states that the purchase is contingent upon your ability to obtain financing at a certain maximum interest rate, and for a certain period of time. If it only states that it is "contingent upon the buyer obtaining financing," without an interest rate or term limit, you could be held to the contract even if all you can get is a 10-year loan at a 15 percent interest rate.
A real estate earnest money contract provision usually indicates that a closing agent or other third party will hold the deposit. However, in a by-owner sale, the seller will sometimes hold the deposit. This is a less desirable way of handling the deposit, as it is more likely to result in the buyer's needing to file a lawsuit to recover the deposit if the sale falls through and the seller refuses to refund the earnest money.
Personal Property Transactions
One of the most common uses of earnest money is in relation to the purchase of a motor vehicle. This includes purchases from a dealer or from a private seller. As with real estate, the earnest money contract is typically part of the purchase agreement, especially when purchasing from a dealer.
A purchase from a private seller also should have a written agreement, outlining the purchase price, how and when payment is to be made, the earnest money paid, and the circumstances under which the earnest money will become the property of the seller or be returned to the buyer.
Unlike with real estate transactions, it is more common for earnest money to be given directly to the seller when personal property is being purchased.
Using a Promissory Note as Earnest Money
Although most sellers are likely to require that earnest money be in the form of cash, check, or money order, they might also agree to accept a promissory note. The drawback for the seller is the possibility of having to file a lawsuit to collect on the note. The advantage for the buyer is not having to file suit to recover the earnest money, which might be required with a cash payment.
Using a promissory note as earnest money is more common in a real estate transaction.