The importance of being earnest: Earnest money & how it affects your real estate purchase

Understand the ins and outs of your home down payment

Buying real estate can be very exciting...until it comes time to write the down payment cheque. First-time home buyers are often stunned when they realize just how much money they need to cough up prior to signing on the dotted line. If you're seriously considering investing in real estate, now's the time to start researching mortgage requirements and down payment minimums that meet your budget.

Earnest money – The down payment before the down payment

Most first time home buyers are familiar with a down payment: a specific amount of money deposited towards the purchase of a new home. The larger your down payment, the more affordable your mortgage; this is because a larger down payment results in a smaller overall interest charge.

But what about the down payment that you pay before the down payment? For example, say that you're interested in purchasing a home for $300,000. Negotiations have been finalized and it's time to sign the contract. At this point, expect your real estate agent to ask for an "earnest money" cheque. This is a small down payment that is included along with the real estate contract to show the buyer that you're 100% committed to the purchase. It's important to note that this cheque doesn't have to be for your entire down payment. It can often be as little as 1% of the purchase price ($3,000 in our example). This cheque simply proves that you're very, very serious about buying the property.

Where does this money go?

This pre-down payment isn't immediately cashed by the home seller – remember, the house isn't technically yours yet. If the home inspection turns out badly, you still have the opportunity to walk away. So, while your home is in limbo, your earnest money is placed into what is known as an escrow account, which is held by the seller's lawyer. This money typically stays in escrow until the deal closes. At this point, you'll be required to sign a cheque for the remainder of your down payment.

What happens to my earnest money if something goes wrong?

Well, this depends on the terms of your purchase contract. Your contract should outline in what scenarios your earnest money will be forfeited, and in what scenarios you would get it back. As such, it's extremely important that you read your contract – every last word of it. Typically, you would receive your earnest money back if:

• the seller changes his or her mind and decides to withdraw from the sale;

• there is a fire in the property before you buy, and you elect to pull out of the deal rather than complete the purchase;

• your offer hinges on a financing contingency, and the lender denies your funding;

• you have a contract with an inspection contingency, and the inspector finds something seriously wrong.

You'll lose your earnest deposit if you, as the buyer, decide to pull out of the deal at the last minute.

The devil is in the details

The only thing worse than losing out on your dream home is having to pay for the privilege. Earnest money is just one of the minor details that can make a big impact on your first-time home buying experience. In order to protect yourself from financial heartbreak, always review your real estate contract closely.