Option money vs earnest money may seem difficult distinguish, but they are different. Option money is exactly what the name it implies. It gives the buyer a period to do inspections and decide whether to buy the house or not. An earnest money deposit (EMD) is also call good faith money because it shows that the buyer is sincere about buying the house.
- Option money allows the buyer a window to conduct due diligence
- Earnest money shows the buyer’s good faith
Option money is non-refundable because the buyer exercises the option during due diligence. On the other hand, EMD may be refundable under certain conditions.
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What is the Purpose of Option Money Vs Earnest Money?
Option money has a specific purpose. According to E-Rae Realty the buyer pays the seller for the right to enter the property and perform any inspections and other due diligence. They have a specified time to perform these tasks.
- The buyer makes the check out to the seller
- The seller can cash the check immediately
- In most cases, it is applied to the purchase price if the buyer moves forward after the due diligence period
People call this an option or due diligence period depending on where you are. You buy the option to buy or walk away for a specified period.
Part of Purchase Price
Option money is not directly part of the purchase price because if the seller decides not to go ahead after inspections, the seller keeps the money. However, if the buyer decides to move forward with the transaction most contracts apply these funds to the sale price.
Does Option Money Go Towards Down Payment?
If you successfully close the property, then the attorneys credit the money toward cash to close. This includes both closing costs and the down payment. For most home buyers which line they lawyer credits the money is irrelevant. However, you can tell your attorney which item you want credited.
Refundable
Do you lose option money? You can get back an option fee in the sense that if you close the transaction, it gets credited to your cash to close.
How Much Should You Pay for an Option to Buy?
Most option fees range from $100 – $500. This depends on the size and value of the property. Another factor is market conditions.
- For a buyer’s market, this fee may be lower or you may not even need it
- For a seller’s market, it may be higher
It is important to talk to your real estate agent about this. You want to put forward your best contract, but you also do not want to pay any more upfront cash than you need to.
What is the Purpose of Earnest Money Vs Option Money?
Earnest money is a larger deposit, and it demonstrates the sincerity of the buyer. If the buyer gets cold feet and walks away without a good reason, then the seller may claim the EMD. That caveat of a good reason is important, though. The contract stipulates those reasons with specific clauses. Most include:
- Home inspection
- Appraisal
- Financing
If there is a major problem with the inspection, the house does not appraise, or the buyer cannot secure a mortgage, then the buyer can recover their EMD. Another common contingency is for a house sale. Many buyers need the money from the sale of one house to buy another. This clause protects them if the sale on their house fails to close.
If you are a buyer and you back out of the deal for a reason not listed in a clause, then you may forfeit your EMD. Therefore, read the contract carefully, and make sure that it adequately protects you.
Part of Purchase Price
Earnest money is not part of the purchase price in the since that it does not lower the sale price. It is credited towards the cash to close. It helps pay the down payment or your closing costs.
Does Earnest Money Go Towards Down Payment?
Earnest money may go towards the down payment. It may also be credited to your closing costs. For most buyers this makes no difference. It is just an accounting item. In either case, it affects the amount of cash you must bring to closing.
Some buyers may have a specific reason to credit toward one or the other. If you want it credited towards the closing costs or down payment specifically you should tell your attorney.
Refundable
In many cases earnest money is refundable. However, there are situations where it is not. It helps to think about the process in two phases:
- During the due diligence, or option period, EMD gets refunded no questions asked if the buyer cancels the deal
- After due diligence the buyer may recover EMD only if a problem triggers a clause
In other words, you have up to a certain date, which is specified in the contract, to walk away, no questions asked. After that, you are locked in and may only recover your money if a specific clause gets triggered.
How Much to Put Down
How much earnest money you should put down depends on the value of the property and the market conditions. Most of the time it is 1% – 5% of the sale price. Therefore, if the home value is $100,000 and you put down 2% you will put $2,000 into escrow as EMD. If you buy a $200,000 house and decide to put down 3%, then you must deposit $6,000 into escrow.
Whether you should put a higher or lower percentage depends on how hot the market is. If you need your contract to stand out from several other offers, then you may want to increase your EMD. On the other hand, if you do not see any competition, you may want to put less money up front. After all, you never know what may happen.
How Do I Cancel Earnest Money?
If you have cause to terminate the deal, then you must follow a process to recover your EMD. New Venture Escrow gives us a good path to follow:
- Write a letter to the seller detailing the issue and which clause(s) you want to invoke
- If the seller agrees you both sign a release form
- Contact the escrow company
If both parties agree, then this process is straightforward and. However, if the seller contests the buyer’s claim, then you will need help from your attorney. It is always a good idea to reach out to your real estate agent to help you draft the letter and navigate the process.
Final Thoughts
Option money is not a widespread practice in most areas for real estate transactions, except in Texas. While it compliments earnest money it is not the same. It is specific to the due diligence period, which is also called an option period in Georgia. On the other hand, earnest money is more significant and shows the sincerity of the buyer throughout that process.
