Understanding the purpose of earnest money – what it does and what is does not do is an important part of the home purchase and selling process. Earnest money simply funds the liquidated damages provision of the purchase and sale agreement between the Buyer and Seller. Basically, if Buyer defaults, Seller is damaged. Seller had the property off the market during the pendancy of the agreement; Seller may have vacated the property in anticipation of closing, Seller may have made repairs or improvements to accomodate Buyer or as required by Buyer's lender, etc. As a result, per the purchase and sale agreement when a Buyer defaults, Seller is entitled to a remedy.
An earnest money provision is a liquidated damages clause entitling Seller to the earnest money in the face of the Buyer's default. So, what is the right amount of earnest money or Buyer's "skin in the game"? !%-2% of the purchase price is pretty standard If the sale is scheduled to close in 20 days, all cash and the house is already vacant, the earnest money could be a low amount as Seller's maximum loss is 20 days of marketing time. However, if the sale is scheduled to close in 60 days and the Seller must install a new roof or vacate early to replace flooring throughout the house, then Seller should demand a substantial amount of earnest money. Seller risks losing 2 months of market time and, the expense of make repairs or vacating prior to closing, if the Buyer fails to close..
If Seller's remedies are limited to forfeiture of earnest money and if the earnest money is insignificant, there is no risk to Buyer for defaulting. Calculating the :right" amount of earnest moneyshould take into account the Seller's anticipated losses in the event the Buyer defaults prior to closing.
Naturally the Buyer wants their earnest money to be the smallest amount possible. For Buyers earnest money should be set . in the confomty with the competetiveness of the market. If Buyer writes a low offer, Buyer may want to increase the earnest money to make Buyer's offer more desireable and to compel the Seller to believe the Buyer fully intends to close the sale. In a strong Seller's market which we have today, Buyer may want to increase earnest money to distinquish Buyer's offer from the expected competing offers.
Earnest money is a negotiation tool to be used by both parties. A Buyer who puts down less earnest money may be signaling less commitment in the purchase.
Setting the right amount of earnest money is alwasy fact-dependent and the client alwasy has the final sayas to the right amount of earnest money.