Option Money vs. Earnest Money

Do you understand the difference between earnest money and option money? My clients in the Austin area often ask me about the difference between option money and earnest money.  In Austin, and the rest of Texas, the buyer must provide two checks once under contract for a property.  Both must be delivered in a timely fashion, and are usually used in residential transactions in Texas.

The option money is non-refundable; however, a good real estate agent, like myself, will make sure the contract specifies that the option money will be applied to the sales price if the buyer determines they want to move forward with the purchase during the option period. The option money is essentially payment to the owner for the right to enter the property and perform any inspections or due diligence necessary within a specified amount of time. This check is made out to the seller, and the seller can cash it immediately. 

The amount of option money and the length of the option period are specified in the contract; however, both are negotiable amounts.  A good general rule of thumb in the Austin real estate market is that the option money should by .1% of the sales price. Thus, for a home with a sales price of $300,000, a $300 option fee is generally an acceptable amount for a 7 day option period. The option period countdown begins the day after the contract is executed and commences at 5 p.m. on the specified date. For example, if you had a 7 day option period, and the contract was executed on the 9th, the option period would end on the 16th at 5 p.m. Holidays and weekends DO NOT matter when determining the date the option period ends.

If the real estate market is incredibly competitive, such as the current Austin market, a shorter option period and/or a higher option money amount is more favorable to the seller.  If the buyer backs out of the contract during the option period, all he or she will lose is the option money, and any money spent on inspections.  The seller prefers a shorter option period since he or she must essentially remove their home from the market while the buyer is "in their option period".  Although the home is not technically off the market, many Austin real estate agents will not show homes that are under contract or "pending back up" status in the MLS.  Similarly, a higher option money amount demonstrates a greater interest in the home since the buyer has more to lose if they decide to back out of the contract during the option period.

The earnest money check is made out to the title company that will be handling the transaction. The earnest money will also be applied to the sales price of the property, and similarly shows what is called consideration.  Essentially, these are the "money talks" portions of an offer. By delivering the earnest money check, the buyer is demonstrating serious interest in and an intent to purchase the specified property. 

It is common practice in Austin for the earnest money amount to be 1% of the sales price.  If we return to the earlier example of a $300,000 sales price, this equates to a $3,000 earnest money check. Again, this is just a recommended amount and can be any amount agreed upon by both parties. The earnest money check is also "cashed" by the title company.  The money leaves the buyer's account and is held in an escrow account.  If the buyer backs out of the contract during the option period, the earnest money will be refunded to the buyer.  Understand, this is a major difference between earnest money and option money; the option money is not refunded if a buyer backs out.

After the option period, the earnest money is essentially held to make sure both parties comply with the requirements of the contract in the time frames specified. There are a number of clauses that protect the buyer's right to have the earnest money refunded if the seller fails to comply with certain provisions within specified time frames.  For example, if the contract specifies that the seller must deliver the seller's disclosure statement within 10 days of the executed date, and the seller fails to do so or delivers it on day 12, the buyer may terminate the contract, and the earnest money will be refunded to the buyer even if they are outside of the option period. For more example, check out this Austin law firm's post on earnest money refunds in Texas.

Do you understand the difference between earnest money and option money in a Texas real estate transaction now?  Want to take a look at homes for sale in Austin, view available houses for sale in Austin now.  If you have any further questions about option money or earnest money, or real estate in general, reach out to me directly! by email [email protected] or phone 512-779-7597