What is Earnest Money?

When you’re ready to buy a home, you’ll quickly encounter the term “earnest money.” This is a part of the home purchasing process that can impact your offer and protect you and the seller.

So, what is earnest money in real estate? Simply put, it’s a deposit you make to show the seller you’re serious about buying their property. Think of earnest money as a financial handshake that says, “I’m committed to this deal.” This good-faith deposit demonstrates your intention to follow through with the purchase.

What is an Earnest Money Deposit?

An earnest money deposit is a security deposit that demonstrates your commitment as a buyer. When you find a home you love and submit an offer, this deposit is a financial pledge of your intention to purchase.

Unlike a verbal promise or even a signed offer, this puts actual dollars behind your intentions. It shows sellers you’re not just browsing properties. It means you’re serious and not making multiple offers simultaneously with no real intention.

Typically, earnest money is held in an escrow account by a third party, such as a title company, real estate brokerage, or escrow company, rather than going directly to the seller. The funds remain in this account until the sale either closes or falls through, at which point, the money is either applied to your closing costs or returned to you, depending on the circumstances.

Does It Go Toward the Down Payment?

When you close on your new home, the earnest money you’ve already paid doesn’t just disappear; it gets applied directly to your down payment or closing costs.

Here’s how it works: Let’s say you’re buying a $300,000 home with a 10 percent down payment ($30,000), and you’ve put down $6,000 in earnest money. At closing, you’ll only need to bring the remaining $24,000 to complete your down payment. The escrow company or attorney handling your earnest money will transfer those funds as directed in your purchase agreement.

Keep in mind that if your lender requires specific documentation about the source of your down payment funds (which is common), you’ll want to maintain clear records of your payment. This includes bank statements showing the withdrawal and documentation from the escrow company confirming receipt of the funds.

When is It Required?

Earnest money enters the picture when you’re ready to submit an offer on a property. Once you’ve found a home you want to purchase, your real estate agent will help you prepare an offer that includes your proposed amount.

If the seller accepts your offer, you’ll need to deliver the deposit within a specific timeframe. This deadline is specified in the purchase agreement and should be taken seriously. Failing to provide the earnest money on time could void your contract and allow the seller to entertain other offers.

The money is usually delivered in the form of a personal check, certified check, or wire transfer to the designated escrow holder identified in your purchase agreement.

How Much Should You Offer?

Determining the right amount of earnest money to offer is a balancing act. You want to demonstrate a serious interest to the seller without overextending yourself financially. While there’s no one-size-fits-all answer, earnest money deposits typically range from 1 percent to 3 percent of the home’s purchase price.

Local market conditions play a big role in determining appropriate earnest money amounts:

• In competitive seller’s markets where multiple offers are common, larger earnest money deposits (sometimes 3-5 percent or higher) can help your offer stand out.
• In buyer’s markets where homes sit longer and sellers have fewer options, you might offer on the lower end of the range.

Regional practices also matter. Some areas of the country traditionally expect higher deposits than others. Your real estate agent is your best resource for understanding what’s customary in your location.

Is Earnest Money Refundable?

Earnest money is often refundable, but it depends entirely on the circumstances of the cancellation and the terms of your purchase agreement. It is typically refundable when you back out of a real estate transaction for reasons covered by contingencies in your contract. Contingencies are specific conditions that must be met for the purchase to proceed. The most common contingencies that can protect your money include:

• Home Inspection Contingency: If inspections reveal issues with the property that weren’t previously disclosed.
• Financing Contingency: If your mortgage application is denied despite good-faith efforts to secure financing.
• Appraisal Contingency: If the home appraises for less than the purchase price, and the seller refuses to renegotiate.
• Title Contingency: If title searches uncover liens, disputes, or other issues that can’t be resolved.
• Home Sale Contingency: If your purchase agreement is contingent on selling your current home, and that sale falls through.

But Not Always…

However, your earnest money is generally not refundable in these situations:

• You change your mind about buying the house for reasons not covered by contingencies.
• You miss deadlines specified in the contract for completing inspections or securing financing.
• You decide to purchase a different property you like better.
• You discover information about the home or neighborhood that you could have learned before making an offer.

The key to protecting your money is ensuring your purchase agreement spells out the conditions under which you can back out and receive a refund. This is why working with an experienced real estate agent and possibly a real estate attorney is so important—they can help ensure your contract includes appropriate protections.

Ready to put your earnest money knowledge into action? The experienced agents at REMAX can guide you through every step of the home buying process, from determining the right earnest money amount to drafting offers with appropriate contingencies that protect your deposit.