Buying a Home? Don't Forget About This Big Expense

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KEY POINTS

  • It remains an incredibly difficult market for home buyers, with higher rates and lack of houses for sale.
  • An earnest money deposit can give you an edge in a seller's market -- it shows a seller you're serious about buying their home.
  • Other ways to get ready to buy in this market include improving your credit and saving as much money as you can ahead of a home purchase.

It's a difficult and expensive time to buy a home. Supply is limited -- according to the National Association of Realtors, there was only a 3.3 months' supply of homes for sale at the end of August (while a four- to six-month supply is generally what's considered necessary to equalize the market between buyers and sellers). Mortgage rates in the 3% range back in 2021 and early 2022 have sadly more than doubled -- as of this writing, Freddie Mac says the average 30-year fixed-rate mortgage is now 7.57%. Ouch!

Despite the rates, prospective buyers are still jockeying for position and making offers on the few homes currently for sale. My theory (as an aspiring 2024 buyer myself) is that people have been waiting and saving money to buy, and are ready to get on the property ladder even if it means signing on for a more expensive mortgage now and refinancing when rates come down.

If you're one of these aspiring buyers, there's a way to give yourself an edge in a tough market and make your offer stand out a bit more. You can make a solid earnest money deposit.

What's earnest money?

An earnest money deposit is money that you (as a potential buyer) promise to a seller as a gesture of good faith when you make an offer to buy their house. It usually amounts to 1% to 3% of the home's purchase price, and if the sale goes through, it's put toward your closing costs and down payment. The money is put into an escrow account (this is the safest way to make an earnest money deposit; you don't want to lose this money to fraud).

Earnest money is also paired with contingencies written into your purchase contract, like a home inspection. If a home inspection turns up issues with the house that make you change your mind about buying it, you can terminate the contract and get your earnest money back. But if you want out of the deal for no established reason, the seller can often keep your deposit.

Why is it particularly important right now?

Making an earnest money deposit is a great way to stand out from the pack of buyers in a market like this one. In some cases, a seller may automatically turn down offers without a deposit. And making a generous one shows a seller that you're really serious about the purchase. Plus, the more you pay as an earnest money deposit, the less you'll have to put down at closing.

What else can you do when buying a home?

In such a difficult market for buyers, there are a few other key moves you should make to put yourself in the best possible position:

  • Dig into your credit report: Mortgage lenders are going to get up close and personal with your finances, so beat them to the punch. Pull your credit reports (free from AnnualCreditReport.com) and look for errors or black marks that should've fallen off your record by now. If you find any, you can ask the credit bureaus to remove them, which will boost your credit score.
  • Improve your credit score otherwise: If you make a renewed commitment to pay your creditors on time (every time) and perhaps pay down some existing debt, you can raise your credit score. A better credit score means a lower interest rate -- which means you save money.
  • Save, save, and save some more: The more money you go into the buying process with, the better. Not just for a down payment (and the earnest money that is a part of that), but also to show a lender that you have cash reserves. Plus, an emergency fund is a wonderful thing to have when you're a homeowner.

Yes, an earnest money deposit is yet one more consideration (and expense) of the home-buying process, but I'd argue it's an especially important one in this current market. If you find the house of your dreams, consider making a solid one -- it'll show the seller you're ready to buy their soon-to-be former home.

Our Research Expert