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A home is a big commitment and one of the numerous things individuals are required to buy a house is to put down a large deposit. This deposit — sometimes referred to as earnest money or a good faith deposit — demonstrates to the seller that you’re serious about purchasing the property.
But have you asked yourself, what happens to that money while you wait to close the deal? Does it simply remain in an account, or is it being used to earn you interest?
In this blog, we will cover if these deposits usually earn interest, what determines whether they do, and if you can work with the seller to earn interest on your deposit. So, if you are a homebuyer or simply interested in the process of real estate, read on to learn more about how your earnest money can work for you!
Do Real Estate Deposits Earn Interest?
When you’re buying a home in the United States, you’ll typically put down a deposit, also known as earnest money, to show that you’re serious about the purchase. This deposit, which is typically a fraction of the purchase price, is kept in a trust account until the sale is completed. But what does that money do while it’s waiting in the account? Does it earn interest?
The General Rule – No Automatic Interest
- Deposits typically don’t earn interest – Deposits usually don’t pay any interest. In many states in the US, there’s no privileged deposits earning anything. That means the cash you place as a deposit won’t grow as it is held in escrow.
- Why no interest? – There are a few reasons that interest is not automatically paid on real estate deposits. For one thing, real estate deals can be complicated, and the closing date isn’t always fixed. Determining interest can be difficult if you are not sure how long the deposit will be held for.
Moreover, any interest that may be payable on a deposit is usually low, particularly if the period of escrow is brief.
How Deposits Are Handled
- Escrow accounts – Real estate deposits are held in escrow accounts. These are handled by a neutral third party, usually an escrow company or a title company. An escrow account is a legal agreement between the buyer, seller, and third party handling the funds. It guarantees the security of the transaction and proper distribution of the funds as per the purchase agreement.
- Non-interest-bearing accounts – Traditionally, most escrow accounts used for real estate deposits are non-interest-bearing. That means they don’t accrue interest. The money just sits there in the account until all of the conditions of the sale have been addressed and the time is right to close the sale.
It’s important to remember that these are general practices, and there can be exceptions depending on your specific circumstances and the laws in your state.
Exceptions and Variations in Interest Earned on Real Estate Deposits
Although the general rule is that real estate deposits don’t automatically accrue interest, there are some notable exceptions:
1. State Laws
- Some states also have laws requiring interest to be paid on real estate deposits. This means that even if the buyer and seller never say anything about it, the seller must pay some interest to the buyer.
- Laws vary from state to state. California has such a law, for example, but not all states do. In any event, it’s good to know the law in the state where you’re buying the house.
- Information about these laws can typically be found on your state’s Real Estate Commission website. This is a government agency that regulates real estate activity in your state. A real estate lawyer can explain the laws to you.
2. Negotiation
- Even if there’s no law in your state about it, you could still request that the seller pay you interest on your deposit. This is something that you can discuss and agree upon when you’re making the offer to purchase the house.
- As part of the offer, it’s wise to put your request for interest in writing. That way everyone understands what you want.
- The home seller may agree to pay interest if they have multiple buyers wanting to purchase the home. They might want to make their offer more appealing to you.
3. Escrow Agreements
- When you buy a house, you usually have an escrow account. This is a special bank account where the money for the house is held until everything is finalized.
- You will also want to get an escrow agreement, which is basically a document that outlines the terms of the escrow account. This agreement tells you whether your deposit will earn interest.
- Read the escrow agreement carefully, and understand what it says about interest. Ask your real estate agent or a lawyer to clarify anything you don’t understand.
Don’t assume that your deposit will or won’t earn interest. Do your research, understand your state’s laws, and don’t hesitate to negotiate!
4 Factors Influencing Interest Accrual
There are several factors that can influence whether or not your real estate deposit accrues interest. Here are some key factors that can affect interest accrual:
1. State Regulations
- State Laws Vary: As discussed before, state laws may vary, and it’s important to understand the specific rules applicable in the jurisdiction where the property is located. Some states pay interest on deposits. Other states may not have any laws specifically addressing it, so it’s up to the buyer and seller to negotiate.
- Check Your State’s Rules: You should be aware of what the specific rules are in your state. You can typically find this information on your state’s Real Estate Commission website or by reaching out to a real estate attorney. Knowing the laws in your area will give you an idea of what to expect and what to negotiate for.
State-Specific Regulations
There are some exceptions on the state level. The states that do, in fact, require interest payments on escrow accounts are:
- Alaska
- California
- Connecticut
- Iowa
- Maine
- Maryland
- Massachusetts
- Minnesota
- New Hampshire
- New York
- Oregon
- Rhode Island
- Utah
- Vermont
- Wisconsin
2. Amount of the Deposit
- Larger Deposits Might Earn Interest – The size of your deposit can also determine whether it earns interest. Since larger deposits would involve a greater amount of money, they may be more likely to earn interest.
If you put down a larger deposit, the potential interest that could be earned on that larger deposit is also significantly larger. This creates more incentive for an escrow company or the seller to put your funds into an interest-bearing account.
- Small Deposits Might Not – A small deposit may not pay interest, as the administrative costs to set up and manage an interest-bearing account may exceed the interest income.
3. Length of Escrow
- Longer Escrow = More Potential Interest – In general, a longer escrow period gives the deposit more time to earn interest. The reason is due to the fact that the money remains in the account longer resulting in more interest.
- Shorter Escrow = Less Potential Interest – If the escrow period is short, the potential for interest earned might not be much, even if the account is interest-bearing.
4. Type of Account
- Interest-Bearing Escrow Accounts – Standard escrow accounts are commonly non-interest-bearing accounts, but there are also interest-bearing escrow accounts. These accounts earn interest on the funds that are held in escrow.
If you’d like to earn interest on your deposit, you might inquire with your escrow company to see whether they have interest-bearing accounts and what the associated terms and conditions are.
- Negotiate the Account Type – You could simply negotiate with the seller that you want to get an interest-bearing escrow account as part of your purchase agreement. Doing so ensures your deposit will earn real estate interest throughout the escrow period.
By understanding these factors, you can be better prepared to negotiate the terms of your real estate deposit!
How to Negotiate Interest on Your Deposit
If you are a buyer and interested in earning money on your real estate deposit, here are a few things you can do to negotiate with your seller:
1. Include it in the Offer
Include a request for interest accrual on your deposit in the purchase offer. You can tell them what interest rate you want to earn or request that the deposit go into an interest-bearing escrow account.
This signals to the seller up front that accruing interest is important to you. It also demonstrates that you’re a serious buyer who is paying attention to the intricacies of the transaction.
2. Discuss with the Seller
Open communication is key to any successful negotiation. If the seller isn’t initially receptive to your request for interest, be prepared to discuss the benefits. You could explain that earning interest helps offset the costs of borrowing money for the down payment or other expenses associated with the purchase.
You could also point out that it’s a fair way to compensate you for the time your money is held in escrow.
3. Consult with a Real Estate Attorney
There are complex legal and financial matters in any real estate transaction. Consulting with a real estate attorney is always a good idea to make sure your interests are protected. A lawyer can help your understanding of your state’s laws regarding interest on deposits.
They can help you craft clear and enforceable language in your purchase agreement and escrow agreement. They can also guide you through how to negotiate effectively with the seller.
By following these steps, you can make the most of your money during the home-buying process.
If you want to learn about the basics of investing in real estate then you can review this article for more details.
Wrapping Up
When it comes to real estate deposits in the USA, it’s important to remember that they don’t automatically earn interest in most cases. That said, there are exceptions based on your state’s laws and your purchase agreement terms. If you care about earning interest on your deposit money, make sure to negotiate with the seller and put this in writing in the contract.
Seek guidance from real estate professionals. They can help you understand your rights and options, and make sure you’re getting the best possible deal. So, prior to making an offer on your dream home, familiarize yourself with your state’s rules for real estate deposits and interest accrual. A bit of negotiation can make all the difference in the world!
