What Is earnest money?

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Understanding earnest money for homebuyers 

Even though buyers don’t often think of earnest money at the beginning of their homebuying process, it’s as important to their budget and to their planning as a down payment or a mortgage. In this article, we’ll cover what it is, how to pay it, and how much you can expect to pay. 

Key takeaways:

  • You’ll be asked to make an earnest money deposit when your offer is accepted
  • Earnest money is not the same thing as a down payment and can be applied to your down payment at closing
  • You could lose your earnest money if you back out, though there are some contingencies that allow you to back out without losing your deposit
  • If the seller backs out, breaches the contract, or doesn’t fulfill a contingency in your contract, your deposit may be returned to you

What is earnest money? 

When you find a home you love and make an offer, the seller will remove it from the market. But in order for the seller to confidently delist the home, they will often ask the buyer to pay a good faith deposit so they won’t back out of the contract. 

It acts as a deposit on the sale of the home and is usually paid when signing the purchase contract (or home offer). Depending on the offer, earnest money can be applied toward the purchase or returned at closing. The buyer and seller will also negotiate on the terms that would force the seller to return the earnest money and release the buyer from their contract. 

Why you’ll be asked to make an earnest money deposit 

An earnest deposit is what’s known as a good faith deposit. It exists to protect the seller in the event that a buyer backs out of a deal. It also generally helps to protect sellers from offers that aren’t serious.

When you make an offer, the seller takes the home off the market to allow the transaction to move forward. But this step can feel risky to the seller since there are a lot of variables that can derail a home offer—the buyer’s financing may fall through, the buyer may simply change their mind, or inspections and appraisals may come back unfavorably. If the seller has to re-list their home all over again, it’s more than just a hassle. They’ll likely have to pay more fees to their listing agent and the home may lose value in the market. Earnest money is meant to protect against the loss and, ideally, hold the buyer to their promise that they’ll honor the contract.

keys on hand
Between making an offer and closing on a home a lot of variables can affect the outcome for both the buyer and seller. Earnest money is how the seller protects themselves in case an offer falls through.

How much is a typical earnest money deposit?

Earnest deposits typically total 1-10% of a home’s purchase price. However, 1-2% is considered standard. The seller is actually responsible for determining earnest deposit amounts.

The general rule is that sellers in hotter markets tend to ask for higher deposits because they have the most to lose if they waste time on an offer that doesn’t go through. Some sellers will request a set amount of money instead of a percentage of a home’s price. It’s not uncommon for sellers requesting flat sums to ask for an amount of earnest money between $5,000 and $15,000.

Making an earnest money deposit

There are several ways to pay earnest money. First, it’s important to know that buyers never give earnest money directly to sellers. The funds are held by a third party. You’ll actually hire a legal firm, title company, real estate brokerage, or escrow company to create an escrow account to hold the money.

Typically, you can send the money using a check or wire transfer. Your funds will stay in the escrow account and, if you are unable to close on the home, the escrow account will liquidate your earnest money funds to the seller. When you do close, though, your escrow total will be applied toward your down payment and closing costs.

How can you lose an earnest money deposit?

You won’t lose your earnest money deposit if the seller backs out. Your contract will also have a long list of contingencies that allow your deposit to be restored to you in other, specific circumstances that you and the seller determine in the purchase agreement. However, the buyer does lose their earnest money deposit in these scenarios: 

  • If you pay deposits on two homes because you can’t make up your mind, you’ll lose the deposit on the one you pass up
  • You get in over your head during a bidding war before deciding that the house you’ve made an offer on isn’t really ideal for you
  • You’ve signed a non-refundable earnest money deposit contract 
  • There are no contingencies in your sales contract 
  • You don’t request an inspection and realize the home is in worse shape than you thought
  • You miss important deadlines on the way to closing that places you in breach of contract
  • You’ve simply fallen in love with another home that you didn’t see on the market when you made the existing offer
  • You’ve changed your mind about buying the home for any non-contingency reason

Ultimately, you should let all of these scenarios serve as cautionary tales. While nothing can be done about a change of heart on your part, you can control whether or not you agree to a contract that doesn’t have reasonable contingencies built in.

How to keep your earnest money deposit

You might still end up with your earnest deposit back if the deal falls through due to a contingency listed on your contract. In the event that you were able to add contractual protections into the purchase agreement, here are the contingencies that may help you get your earnest money back: 

  • Financing contingency

Your contract states that you are on the hook for buying the home only once your lender approves and underwrites your loan. 

  • Appraisal contingency

If the home appraises for a lower value than the offer, you may back out of the contract and get your earnest money back. 

  • Inspection contingency

When a major issue is discovered by an inspector that would affect the price or value of the home, you may terminate the contract and retrieve your deposit.

  • Sale contingency

You add a clause to the contract that you are only going to buy the home when your previous one sells so that if your home doesn’t sell, you can back out and get your deposit back. 

  • Title contingency

If there are any liens, covenants, or restrictions on the property, you may back out and the seller is required to return your deposit.

Deadlines and timelines for executing these contingencies vary based on local real estate laws. Typically the due diligence period can last anywhere from one to three weeks. During this period, you’ll be responsible for the appraisal, inspection, land survey, and title search.

coins in clear glass jar with house fund sign
Earnest money can either be a percentage of the purchase price of the home or a flat fee, but buyers need to make sure this initial deposit is part of their budget

Protecting your earnest money

Avoid losing your deposit by doing your homework first. Some sellers in hotter markets may take advantage of eager buyers who waive contingencies to provide a tempting offer. These tips can save you from heartache when you try to buy a home:

  • Carefully read the terms of the purchase contract 

Make sure you clearly understand what everything means! Ask your real estate agent for help with clarifying certain details if anything seems ambiguous.

  • Abide by the terms of the purchase agreement 

The seller will also have their own contingencies you have to meet. Prepare for them by sticking to timelines and preparing your accounts.

  • Verify that contingencies for financing, appraisals, and inspections are built into the contract

Decide what protections you need beforehand so that if anything goes wrong in the offer, you’re not on the hook.

  • Ensure that your deposit is handled correctly 

While you will present escrow details to show the seller that you’ve fulfilled your obligation, the deposit should only be payable to a third-party entity. Always request a receipt after depositing money!

Don’t forget that your ability to retrieve your escrow account is valid up until closing. If promised repairs have not been made by the time you make your final walkthrough a few days before closing, your contract contingencies may allow for you to void the contract. But remember that the seller also has a right to execute contingencies right up through closing.

Final Thoughts

Avoiding losing your deposit comes down to knowing what you want, knowing your rights, and knowing that nobody can predict what will happen during a real estate transaction with 100% accuracy. Providing a deposit doesn’t mean that a seller is forced to sell you the home under any condition. However, there’s generally a pretty good chance that the deal is going to close once that escrow account has been created.

FAQs

Do you get earnest money back?

The answer depends on the terms of your contract. Contingencies related to financing, appraisals, home inspections, and home title can all allow you to have your earnest money returned to you. However, you will likely lose your earnest money if you back out of a sale.

Who gets earnest money when the seller backs out?

If the seller backs out for a reason that is not covered under a seller contingency built into the contract, the money is returned to the buyer.

Can a seller keep my earnest money?

Yes, there are many situations where a seller can keep a buyer’s earnest money. The most common reason is that a buyer backs out of a sale. A seller may also be entitled to earnest money if a buyer breaches the contract in any way.

How much earnest money should I put down?

Most earnest money deposits total between 1% and 2% of an offer.

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