Key Takeaways
- Earnest money is a refundable deposit submitted with a home offer to demonstrate serious intent.
- It is typically 1% to 3% of the purchase price, though it can be higher in competitive markets.
- The money is held in an escrow account until closing.
- Earnest money is usually applied toward your down payment or closing costs if the deal goes through.
- You may lose your earnest money if you back out of the contract without a valid contingency.
How Does an Earnest Money Deposit Work?
When you’re in the thick of the home buying process, it’s easy to forget that sellers on the other side are also contributing ample time and energy into making their property appealing for buyers. After the effort of listing, sellers want to ensure that interested buyers are serious about the purchase, which is where earnest money comes in.
Earnest money is often called a “good faith deposit” that’s submitted with your offer (separately from your down payment) and typically equals 1% to 3% of the home’s purchase price. Keep in mind, if you’re looking to buy in a competitive market you may need to adjust up in order to strengthen your bid.
If the seller accepts the offer, the funds are typically due within one to three business days (though timelines may vary based on the purchase agreement) and are then placed into an escrow account that’s held by a neutral third-party like a title company or real estate brokerage.
The deposit stays in escrow while the transaction moves through inspections, appraisal, and underwriting. At closing, the earnest money is typically applied to the buyer’s down payment or closing costs.
Is Earnest Money Refundable?
Earnest deposits are generally refundable if you cancel the contract for a reason allowed under your purchase agreement.
Most real estate contracts include contingencies that protect buyers. A contingency allows you to cancel the contract for a specific reason without forfeiting your earnest money. Common examples include:
- Home inspection contingency: Allows the buyer to back out or renegotiate if the home inspection reveals significant issues that the seller is unwilling to address.
- Appraisal contingency: Protects the buyer if the home appraises for less than the agreed upon purchase price, giving them the option to cancel or renegotiate.
- Financing contingency: Allows the buyer to cancel the contract if they are unable to secure mortgage approval within the agreed timeframe.
- Title contingency: Gives the buyer the right to withdraw if problems are discovered with the property’s title, such as liens or ownership disputes.
If you back out for a reason covered by one of these contingencies and follow your contract’s deadlines, your earnest money is typically returned to you.
However, if you miss contractual deadlines or withdraw for a reason not covered by a contingency, the seller may be entitled to keep the deposit. In many contracts, earnest money can function as liquidated damages, meaning the seller may claim the deposit as compensation for the buyer’s breach of contract.
Earnest Money Deposits at Closing
If the transaction closes successfully, the earnest deposit is credited toward your total cash due at closing. It reduces the amount you need to bring to the closing table because you have already contributed part of the funds.
For example, if you owe $25,000 in combined down payment and closing costs and you previously submitted $8,000 in earnest money, you would bring the remaining $17,000 to closing.
Is Earnest Money Required?
While earnest money isn’t legally required, it’s an expected part of the process that sellers want to see in order to feel confident with the sale and you as a motivated buyer. Offers without earnest money are often viewed as weaker, especially in competitive markets. In hot markets, a larger deposit can signal financial strength and commitment, though buyers should balance that strategy with the risks involved.
FAQs About Earnest Money
If a buyer cancels outside the terms of the contract, a seller may have the right to claim the deposit. Disputes are resolved according to the purchase agreement and local law.
Earnest money is a deposit made shortly after an offer is accepted to show serious intent. A down payment is the portion of the home’s purchase price you pay at closing. If the transaction moves forward, earnest money is typically credited toward your down payment or closing costs.
Who ultimately receives the earnest money depends on the reason the contract was canceled. If the buyer withdraws under a valid contingency and within the agreed deadlines, the deposit is usually returned. If the buyer breaches the contract, the seller may be entitled to keep the funds as compensation.
In some situations, buyers may increase their earnest money deposit to strengthen their position, especially in competitive markets. Any change would require an updated agreement signed by both parties.
