What is Earnest Money?

When you’re buying a home, you will often make an earnest money deposit to the seller after they have accepted your offer. While they are not always required, this good faith deposit can give you an edge in a competitive market. Once you close on the home, the earnest money can be applied to your down payment. Let’s take a closer look at this practice and answer common questions that often come up.

How much earnest money should you offer?

One of the most frequent questions we get is about how much earnest money to offer. Typically, the earnest money deposit is one- to two percent of the purchase price. But this can vary depending on the market. When we’re in a seller’s market, like we are now, some buyers may opt to increase their earnest money deposit as a way to make their offer stand out. If you’re not sure how much earnest money to offer, talk to your real estate agent.

What does earnest money provide?

Once your offer has been accepted by the seller, they will take their home off the market. The earnest money helps to assure them that you’re operating in good faith and intend to close the deal. In many cases, your earnest money deposit is not refundable if you back out of the deal. This deposit provides the seller with compensation should that happen. Basically, your earnest money deposit shows that you’re serious about following through.

What happens to your earnest money?

A purchase agreement will be drawn up between you and the seller. This document will provide details about how the earnest money deposit is to be handled. Usually, the money is held in escrow until you close on the house. At closing, most buyers will use the earnest money as part of their down payment on the house.

Can a seller legally keep my earnest money?

There are certain situations where the seller is legally allowed to keep your earnest money deposit if you don’t go through with the deal. These terms will be laid out in the purchase agreement. For example, if you decide not to continue with the purchase because you found a home you like better, then the seller may be able to keep your earnest money. Before you sign your purchase agreement, make sure you understand exactly what you are agreeing to. If anything is confusing, then have your agent explain it.

When can my earnest money be refunded?

There are also situations where you can get your earnest money refunded if you don’t close the deal. These will also be laid out in the contract, and are usually referred to as contingencies. Common contingencies include:

• Mortgage contingency -- If you’re unable to secure financing to buy the home, then you can get your earnest money returned.
• Inspection contingency -- If the house inspection uncovers major problems, then you may be able to get your money back if you don’t follow through on the purchase.
• Appraisal contingency -- If the home appraises for less than the purchase price and the deal falls through, you can get your earnest money back.

The bottom line

Your earnest money deposit is a valuable tool that can help your offer stand out among the competition. But before you sign any contracts, be sure you understand exactly what you’re agreeing to. When in doubt, ask your real estate agent to walk you through the contract before you sign.