What Is Earnest Money in Real Estate?

Learn About Earnest Money Deposits When Buying a House

Earnest money is a deposit a home buyer makes during the purchasing process. If you’re trying to convince a seller to accept your offer to buy their house, you’ll most likely need to provide an earnest money deposit.

This guide will explain what earnest money is in real estate, why it is so important to offer an earnest money deposit, and what happens to earnest money at closing. 

What Is an Earnest Money Deposit?

Earnest money is money you’ll put down as a home buyer to show a seller you’re serious about wanting to purchase a property. It's also called a “good faith deposit.” You’ll typically put down this money when you make an offer on a house make an offer on a house. 

Your earnest money is usually kept in an escrow account escrow account until the sale of the home closes, when it will be applied to your down payment or closing costs. Sometimes you’ll be able to get your earnest money refunded if the sale of the home falls through. Your ability to get a refund depends on the terms of the purchase agreement between the buyer and seller. 

Why Do You Need to Pay Earnest Money?

The purpose of earnest money is to show you are serious about making the purchase. If the seller accepts the offer, and you walk away from the sale for reasons other than those covered by contingencies (conditions) in the contract, the seller can keep the earnest money deposit.

When homeowners accept a bid, they take the home off the market until the sale of the home closes. While they might still be able to show the home and receive backup offers, interested parties might steer clear of a home with a contingent or pending sale. If the sale doesn’t close, the homeowner can lose time and money putting the house back on the market and finding another buyer. In some instances, the seller may get to keep the earnest money.

How Earnest Money Works

Now you know what earnest money is, we’ll go over how it works in practice. 

• When you make an offer to buy a house, you'll offer a certain amount of earnest money. The purchase agreement specifies the deadline to make the earnest money deposit from the time the contract is signed. It's usually a few days.
• If your purchase offer is accepted, you’ll deposit the earnest money in an escrow account.  This account is managed by a neutral third party like a real estate attorney or title company. It will be held there while contingencies (conditions of the sale) are met and you secure financing. 
• If you walk away from the sale without justification, the earnest money is paid to the seller.
• If a contingency or condition is not satisfied, the earnest money is returned to you as the buyer when you cancel the contract.
• If the sale is completed, the earnest money will go towards the closing costs or down payment for the home.

How Much Earnest Money Should You Put Down?

Earnest money deposits usually range between 1% and 5% of the purchase price. This means that if you want to buy a $300,000 house, you might need to make an earnest money payment between $3,000 and $15,000.

There is no hard-and-fast rule on how much your earnest money deposit should be. In a market where sellers may receive multiple offers on their houses, a higher deposit may make your bid more attractive.

As long as the purchase agreement is written correctly with the right pre-conditions in place, there's no downside for a buyer to make a larger earnest money deposit because either the money is applied to your costs at closing, or you get it back if the contingencies are not satisfied.

Is Earnest Money Refundable?

Your earnest money deposit can be refundable if you attach contingencies, in writing, to your offer to buy a house. Contingencies create conditions that must be met before the sale closes. Here are some common homebuying contingencies to include in your purchase agreement:

• Appraisal contingency: An appraisal contingency requires that the home appraisal show the fair market value of the house is equal to or above a set price (usually, the price you are paying for the house).
• Title search contingency: A title search confirms that the seller is the legal owner of the house and that there are no liens or claims on the property that might affect your ownership rights if you buy the house.
• An inspection contingency: This makes the sale contingent on a home inspection to ensure there are no unexpected structural issues or problems that require expensive repairs.
• Financing contingency: The sale is contingent on the buyer being able to secure financing. Sometimes, the contingency specifies that the mortgage loan must be below a certain rate. 
• Home sale contingency: If you already have a home that you own and you want to make the purchase of the new property contingent on selling your home first, you can include a home sale contingency. 

Protecting Your Earnest Deposit

You need to take certain steps to protect your earnest money deposit.

• Send the funds only to a trusted escrow company. You'll usually do a wire transfer to move the money to an escrow account held by a title company or an attorney. Properly research to ensure you’re sending your money to a legitimate company or individual.
• Include the right contingencies. If your contract does not include a specific condition (or set of conditions) that you want met, then you’re at risk of being unable to enforce that condition or unable to seek return of the deposit as a result.  
• Know the deadlines. Your purchase agreement may give you a limited time to satisfy each contingency. For example, if you don't have the appraisal or inspection completed in time, this could be viewed as waiving that condition.  If you have an appraisal or inspection completed and the condition isn't satisfied, be sure to notify the seller right away.

Earnest Money FAQs

Still need to know more? Here are the answers to some frequently asked questions about earnest money. 

Does Earnest Money Go Toward Your Down Payment or Closing Costs?

Yes. When the sale of a home closes, your earnest money is typically applied to your down payment or closing costs. The company that manages the escrow account holding your earnest money makes sure it’s paid to the right organization during closing.

What Happens to Earnest Money at Closing?

Earnest money is applied to your costs at closing. It could make up part of your down payment, or it could go toward covering other expenses, such as a title search. The escrow company routes the money either to the seller or to the company or individual who’s being paid for services, such as the county for the title transfer or the title insurance company for provided coverage.

Who Keeps Earnest Money if a Deal Falls Through?

If a home sale falls through because a buyer contingency specified in the purchase agreement is not satisfied, then the buyer's earnest money deposit is returned. If the buyer walks away from the sale without a justified reason, as specified in the contract, then the seller gets to keep the earnest money. 

Final Thoughts: Earnest Money

If you are planning to buy a house, you should be ready to make an earnest money deposit. A large deposit may make your offer more competitive, so be prepared to transfer the funds to escrow if your offer is accepted. 

Sending your earnest money to escrow is just one of many steps you'll need to take as you prepare to close on your home loan. Be sure to reach out to a loan specialist, such as Freedom Mortgage, early to explore your options for a mortgage, and keep in regular contact throughout the financing process so your closing goes off without a hitch.