The buyer will be required to provide option money and earnest money to the title company once they find a home and execute a contract in the home loan process. The option and earnest money must come from an acceptable source of funds (i.e. not a briefcase of cash). Both amounts will be applied towards the buyer’s down payment and closing costs at closing on the Closing Disclosure (CD). Beware, both amounts are “at risk” until closing.
Option & Earnest Money
Most residential purchase contracts are written so that closing occurs in 30 days. There are three distinct timelines defined in the contract. The first is the option period, the second is the financing period, and the last is the “let’s do this” period. (Okay, the last period doesn’t have an official name. It’s the period of time that exists after the financing period expires and before the closing).
The option period is typically 10 days and allows the buyer to access the home for various inspections, like the home inspection. During the option period the borrower may terminate the contract without just cause and be refunded the earnest money. While the buyer can terminate during the option period and be refunded their earnest money they will forfeit their option money to the seller. Think of the option money as a way of compensating the sellers for taking their home off the market while buyer determines if they ultimately want to move forward with the purchase.
The option money check will be made payable to the seller. Option money typically ranges from $100 to $300 depending on the purchase price of the home. The option money will be credited to the buyer at closing; however, should the buyer decide to cancel the contract this money will be forfeited to the seller. Note: new construction loans typically do not require any option money. They only require earnest money.
Once the option period expires the financing period take over and the earnest money is at risk. Should a buyer terminate the contract after the option period expires they will lose both the option money and earnest money to the seller. The financing period protects the borrower in the event the financing cannot be obtained. The financing period is typically totals 20 to 25 days (starting from the date of executing the contract). During this time the buyer will be refunded their earnest money should financing fall through.
The earnest money is typically about 1% of the purchase price (or $10,000 for new construction). Like the option money, the earnest money will be credited to the buyer at closing and is applied towards your down payment or closing costs.
Let’s assume the option period has expired and the appraisal shows the home’s value to be $5,000 below the purchase price. This impacts the mortgage financing and may (depending on the borrower and/or loan program) make financing unobtainable. At this juncture, the borrower can terminate the contract and receive a refund for the earnest money so long as the financing period hasn’t expired.
Another example could be that the borrower loses their job before closing. If it’s within the financing period then the earnest money is returned if financing cannot be obtained. However, if the financing period has expired then the worst case scenario occurs and the borrower loses their earnest money.
Documentation for Option and Earnest Money
The mortgage world will need copies of the canceled checks AND a bank statement showing the funds leaving your bank account. If these funds were a gift or a loan from someone then contacts us immediately to discuss.
FYI, if you’re buying new construction then be proactive and save your bank statement showing the canceled check after the earnest money clears since it may be six to eight months before you close. It’s a pain to go back and find that paperwork later. Feel free to send that documentation to us. We’ll put it in the file so you don’t have to worry about it down the road.