Earnest money is a deposit buyers place on a home during the buying process. This shows the seller that the buyer is serious about purchasing the home. Buyers are not obligated to buy the home at this point, but the seller may receive the earnest money should the buyer back out. If the sale goes through, the earnest money is applied to the down payment or closing cost.
Let’s say you found your dream home. It’s in the perfect location and has everything you’re looking for. However, the competitive real estate market means you’re just one of a dozen offers put on the home. How do you stand out? How do you show a seller that you’re serious about purchasing the home? This is where an earnest money deposit comes into place.
Earnest money both distinguishes the buyer and protects the seller. But how can you be sure your money is safe in an earnest deposit? And is there any chance you can get your money back if you pull out of the deal? Keep reading to learn more about earnest money and contingencies.
What is earnest money?
Earnest money is a security deposit potential buyers place on a home. This is to show the seller they are serious about purchasing the property. After agreeing on purchase agreement terms, the buyer supplies the deposit and the seller takes the home off the market. However, the buyer is not obligated to buy the home.
To keep the earnest money safe, a real estate agent places the earnest money directly into an escrow account until closing.
How does this differ from a good faith deposit?
The terms “earnest money” and “good faith deposit” are often used interchangeably. Both show commitment to buying a home, and both are put towards homebuying expenses should the deal go through. However, if you want to get technical about it, these funds are held by different parties.
A buyer provides earnest money to the seller, while a good faith deposit is given to the lender. A good faith deposit may pay for credit checks, appraisals, and costs that come with processing a loan.
How do I determine the amount of the earnest money deposit?
Your real estate agent can help you determine an exact amount, but it’s usually 1% to 3% of the home’s purchase price.
Depending on how intense the bidding war is for the property, you may want to offer a large deposit. Not only does this show how dedicated you are to purchasing the property, but a large deposit also demonstrates your financial security. This may attract a seller’s attention.
How does an earnest money deposit help me?
Earnest money helps both the potential buyer and the seller. For a buyer, this deposit helps them stand out in a competitive real estate market. It’s worth noting that there are scenarios where a homebuyer can get their money back if certain contingencies are not met.
An earnest money deposit helps the seller if the buyer backs out of the sale. A seller takes their home off the market once they enter a purchase agreement with the buyer. If the deal falls through and the seller has to relist the home, it could be a major financial hit on the seller. An earnest money deposit ensures the seller is compensated should the buyer simply get cold feet.
Do I pay earnest money upfront?
A buyer applies earnest money upfront as part of the initial offer to the seller. This money is then held in an escrow account until the sale closes. In most states, the buyer and seller must complete and sign an earnest money form along with the purchase agreement.
If the sale falls through, the earnest money is given to the deserving party, which may change depending on the purchase agreement terms.
What payment method do I use for an earnest money deposit?
Acceptable payment methods are a personal check, wire transfer, or certified check. Your real estate agent can help you with any further questions regarding payment methods.
How do contingencies protect earnest money?
Most purchase agreements have contingencies, which help the buyer get their earnest money deposit back under specific circumstances.
There are five common loan contingencies:
- Home inspection. This allows the buyer to walk away with their earnest money if the home inspection reveals a major issue.
- Clear title. This contingency refunds the buyer if a title company finds an unresolvable issue.
- Home appraisal. The buyer may walk away if the seller lowers the price or the home appraisal is significantly lower than the purchase price. With a home appraisal contingency, the buyer is entitled to the earnest money deposit.
- Mortgage financing. This gives the buyer time to find a way to finance the home. If the buyer’s mortgage financing falls through, or if it falls through, the buyer can back out. This contingency allows the earnest money deposit to be refunded to the buyer.
- Home sale. Buyers use a home sale contingency if they are trying to sell their current home before buying a new one. This protects the buyer against paying two mortgages. Not all sellers accept this contingency. It could lead them to turn down other offers while they wait for the buyer to sell their home.
If you’re not sure what to include in your purchase agreement, speak to an experienced real estate agent or a real estate attorney.
What happens after I make an earnest money deposit?
Depending on how the sale progresses, there are a few things that could happen with your earnest money deposit. Below, we’ll outline a few scenarios and what happens to your earnest money deposit in these cases.
For the sake of these examples, let’s say Mary just placed an earnest money deposit on Bill’s home. The listing shows the home is selling for $300,000, so Mary prepares a $6,000 earnest money deposit (2% of the purchase price).
1.) The sale goes through
Mary and Bill agree to and sign a purchase agreement, at which point Mary provides the earnest money deposit. The home passes all home inspections, and the title company does not find any liens on the property.
Mary agrees to purchase the home from Bill. Her deposit is removed from the escrow account and applied to the home’s down payment or closing costs.
2.) The buyer backs out
Mary likes Bill’s home and offers an earnest money deposit after they sign a purchase contract. The property passes home inspections, no liens exist on the home, and Mary has no problem applying for a mortgage.
However, Mary finds a house she likes even better during this process. She decides to withdraw from the sale. Since Bill must relist the home now, he keeps the earnest money deposit.
3.) Failed contingencies
Mary likes Bill’s home and submits an earnest money deposit after agreeing on a few contingencies in the purchase agreement. This includes clear title and home inspection contingencies, which make the earnest money refundable.
During the home inspection, the inspector finds several leaks in the roof and recommends completing significant repairs on the foundation. Mary finds the repairs will cost thousands of dollars she didn’t anticipate and pulls out of the deal.
Because of the contingencies, Mary gets her earnest money back.
How can I avoid financing issues during this process?
Buying a home is a long and stressful process, especially if you have to fight for your dream home amidst a bidding war. To stand out in the crowd, you may want to bring more than just an earnest deposit.
While earnest money demonstrates your seriousness to purchase the property, a preapproval letter from your mortgage lender will confirm this intention. A preapproval letter will also reduce any risk in offering a deposit because you can clearly show your financial health.
Having trouble finding the right mortgage lender? We can help! SuperMoney contains dozens of reviews on home loan lenders from across the nation. This allows you to search for your ideal loan terms without leaving the comfort of your home.
What happens if the buyer puts down a non-refundable deposit?
Non-refundable deposits are rare in the housing market, but it is possible. This deposit works similar to earnest money, where the buyer offers upfront funding to stand out in a super competitive market.
While this could help the buyer get the house, non-refundable deposits are risky. If the sale does not go through, the seller gets the earnest money deposit, regardless of why the sale falls through.
How much earnest money should you put down?
A typical earnest deposit is around 1% to 3% of the sale price. A real estate agent can give you a specific idea of how much earnest money to put down. If the sale goes smoothly, the earnest money goes toward the down payment or closing costs.
However, it’s important that you hold your earnest money with an escrow company rather than giving it directly to the seller. There’s always a chance that the seller, or even real estate brokerage, is fraudulent.
Is earnest money required?
While an earnest money deposit isn’t required, it can help a buyer stand out. Earnest money is particularly valuable in a competitive real estate market since it demonstrates the buyer’s intention to purchase the property.
- Earnest money is a deposit buyers place on a home to show they are serious about buying the house.
- Loan contingencies can help buyers keep their earnest money if the sale falls through.
- The earnest money stays in an escrow account and is later added to the down payment or closing cost should the sale close.
- Even with contingencies in place, it’s possible for the home seller to keep the deposit.
- Earnest money deposits are useful in a competitive real estate market.
Secure financing for your dream home
No matter where you are in the home-buying process, securing financing is one of the most important steps. Maybe you’ve put it off because you’re worried to hear your rates, or maybe you don’t know where to start. No problem!
SuperMoney provides thorough reviews and comparisons of today’s top mortgage lenders. Not only can you customize by location, but you can also specify what kind of loan you’re looking for. Check it out today!
- HUD Earnest Money Forfeiture and Return Policy — U.S. Department of Housing and Urban Development
- Questions and Answers on: Earnest Money Deposits — North Carolina Real Estate Commission
- 10 Smart Questions To Ask A Real Estate Agent When Purchasing A Home — SuperMoney
- How to Get a Home Improvement Loan with No Equity — SuperMoney
- Bi-Weekly Mortgage Payments: Are They Worth It? — SuperMoney
Camilla has a background in journalism and business communications. She specializes in writing complex information in understandable ways. She has written on a variety of topics including money, science, personal finance, politics, and more. Her work has been published in the HuffPost, KSL.com, Deseret News, and more.