What is the Difference Between an Earnest Money Deposit and a Security Deposit?
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Originally Posted On: https://www.dohardmoney.com/what-is-the-difference-between-an-earnest-money-deposit-and-a-security-deposit/
The phrase “security deposit” often gets used as an umbrella term for any real estate transaction that requires money down before a property is made available. If you’ve been a renter your whole life and are looking to become a homeowner, you may be confused when you hear the term “earnest money.” Is that the same thing as a security deposit? If not, what’s the difference between an earnest money deposit and a security deposit?
Security deposits are most often seen in rental agreements. A tenant will put some amount of money, usually about a month’s worth of rent, up to guarantee that they will take care of the property. If they don’t, the security deposit can be used to make things right. Earnest money is used exclusively in real estate purchasing. An earnest money deposit is an amount of collateral a buyer will put up to secure their position while going through the contract process to close on the home. If the buyer doesn’t meet specific deadlines for things like inspections and appraisals, they may forfeit their earnest money deposit.
Whether you’re a landlord, tenant, or getting into real estate, it’s essential to understand the nuances between these two types of deposits. So let’s talk about what a security deposit does, what an earnest money deposit does, and what to look out for in your real estate contracts.
What is a Security Deposit?
Security deposits are most often found in rental contracts. That extra $500 you and your roommates had to scrounge together in college to get your off-campus apartment? That was a security deposit.
The tenant pays a security deposit before moving into the rental property. Essentially, it’s the guarantee that “I, the tenant, won’t destroy this home when I leave. But if I do, this deposit will cover it.”
These deposits are often the equivalent of an extra month of rent, but it’s whatever amount the landlord wants to charge. There can also be additional deposits for things like pets. Whatever deposits are required, though, must be in the rental agreement; the landlord can’t tack on additional deposits down the road.
Rules for How a Security Deposit Can Be Used
Security deposits are often kept in an escrow account that ensures it’s secured and can’t be spent by the landlord while the tenant is occupying the home. Sometimes, landlords will not only give back the security deposit but may also include any interest accrued in escrow. There are some states which require this, but it’s rare. In most cases, the tenant should just expect to receive the principal deposit back.
If the tenant leaves the property in a state of disarray, the landlord can deduct any costs they incur from the security deposit. Any costs the landlord charges must be documented, including:
- Why the costs have been deducted
- How much it costs to repair or replace the damage
If there’s any deposit remaining, they’re required to return that to the tenant. This most often comes in the form of a check mailed to the tenant’s new address, but some more tech-savvy landlords have started using things like Venmo or wire transfers.
Earlier, I mentioned that landlords couldn’t just tack on extra deposits after the rental agreement is signed, but this doesn’t completely clear the tenant. If you, as the renter, leave the property with excessive wear and tear that goes above what the security deposit will cover, your former landlord can go after you for the difference.
What is an Earnest Money Deposit?
Unlike a security deposit, earnest money deposits are not extra fees. Earnest money is what’s known as a “consideration” in real estate. Consideration only means that you’re putting something of value up as a deposit to be forfeited if you cannot follow through. Most often, this is some amount of money, but not always. It can be collateral or something else the seller’s representatives feel is fair.
While security deposits are used in rental agreements, earnest money deposits are used for purchasing a property. Another difference between security and earnest money deposits is that earnest money goes towards the final purchase price. So if you put down $5,000 in earnest money for a home you’re going to purchase, you can expect to see that $5k put towards your down payment or closing costs. Check with your lender to see how they prefer it to be used.
How Much Earnest Money Will I Need?
There’s no set amount that’s required to put down in earnest. Typically, if you’re buying a property that’s listed on the MLS, you should expect to pay anywhere from $5,000 to $10,000 in earnest money.
However, if you can find an off-market property, you may be able to put much less down. I’ve been able to drop only $25 or $50 in earnest money because of the lack of competition vying for the home.
One tip: make sure that your earnest money deposit goes to the title company and not directly to the seller. While in most cases, your seller will be honest and professional, it’s best to have a third party as a go-between when it comes to things like deadlines, money, and who gets what.
Can I Get My Earnest Money Back?
Similar to a security deposit, earnest money can be lost by the buyer. If you, as the buyer, are unable to meet specific deadlines and don’t pull out of the contract beforehand, the seller will be able to keep that money.
The good news is that it’s not as scary as you think; it’s pretty easy to pull out of a contract and successfully receive your deposit back. There are a few milestones you should be aware of, though, to help make sure you get what’s owed back to you.
Deadlines That Will Affect Your Earnest Money Deposit:
Inspection and due diligence – Inspection and due diligence mean the same thing: You’ve walked through the property and given it a good once over. Usually, an inspection is done by a licensed professional, and you as the buyer should make every effort to be there with them. You can ask as many questions as you like; believe me, they’re used to it.
Let’s say you’ve found something during inspection or your research that makes you want to walk away from purchasing the home. As long as your inspection is done before a certain deadline stipulated in your contract, the earnest money is refundable.
Loan denial deadline – Getting pre-approved for a loan doesn’t mean you’re 100% in the clear. If the mortgage you were counting on falls apart before the stipulated loan denial deadline, your earnest money can be refunded.
Appraisal provision – Make sure that you have the home appraised before signing the purchase contract. If the property doesn’t appraise for the price you’re buying it for, and you’ve done this before the stipulated deadline, your earnest money is refundable.
While security deposits and earnest money deposits have similar purposes, the way they each function is significantly different from the other. No matter if you’re a landlord, tenant, home buyer, or home seller, it’s in your interest to make sure all bases are covered in your legal agreements. Be sure you understand what your deposit is going towards, how it will be used, and whether or not you can expect to get the deposit back.
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