What is Earnest Money?

Earnest money is a deposit made by a home buyer to show they are serious about purchasing a property.

A Longer Definition: Earnest Money

Earnest money, also known as a good faith deposit, is a small percentage of the home’s purchase price paid by the buyer to the seller as a token of the buyer’s commitment to complete the transaction.

Earnest money assures the seller that the buyer is serious about their offer and intends to follow through with the purchase.

Most sellers will not change their home’s For Sale status to “pending home sale” or “under contract” until an earnest money check is received. The seller can keep earnest money if the buyer walks away from the transaction later without a contingency-based reason.

However, if the purchase transaction falls through and there are contingencies in the contract to protect the buyer, the earnest money can be refunded. Common scenarios that result in an earnest money refund include a failed home inspection or the seller’s inability to produce a clean title report.

Earnest money is typically held in an escrow account managed by a third party, like a real estate brokerage, law firm, or title company, until closing. Then, at closing. the earnest money deposit is withdrawn from the escrow account and applied to the purchase transaction – usually as cash toward a down payment.

For no-downpayment mortgages such as USDA mortgages and VA loans, earnest money is typically applied to closing costs or prepaid expenses.

Earnest money deposits can vary from a few hundred dollars to 10% of the home’s purchase price or more, depending on the local real estate market and customs.

Earnest Money: A Real World Example

Imagine first-time home buyers who find their dream home listed for sale. To show their serious intent to purchase the home and stand out among other potential buyers, they make a strong offer that includes an equally strong earnest money deposit of 5% of the purchase price.

Their offer gets accepted, and the home buyers’ good faith deposit is placed in an escrow account with the title company. Later, the home passes its home inspection, and its title is shown to be clean.

The mortgage is approved, and the home buyers go to closing, where their earnest money is applied to their downpayment and closing costs due.

Common Questions About Earnest Money

What happens to my earnest money if the deal falls through?

If a home sale falls through due to a contingency outlined in the contract, such as a failed home inspection or the buyer not getting a mortgage, the earnest money is typically refunded to the buyer. However, if the buyer backs out for reasons not covered by contingencies, the seller may keep the earnest money.

Is my earnest money the same thing as my downpayment?

No, earnest money is not the same as a down payment, although a home buyer can credit their earnest money toward their eventual downpayment later. Earnest money is paid upfront to demonstrate a buyer’s interest in a property. Downpayments are the cash you pay toward your home purchase price at closing.

How much earnest money should I pay?

Earnest money deposits usually range between 1% to 3% of the home’s purchase price, but there are no rules for how big or small can be. Your real estate agent can provide guidance based on your specific situation and local market conditions.