What is Earnest Money?

Earnest money is a deposit made by a home buyer to show that 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 sign of the buyer’s commitment to completing the transaction.

Earnest money reassures the seller that the buyer is serious about the offer and intends to proceed 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 may keep the earnest money if the buyer walks away from the transaction without a contingency-based reason.

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

Earnest money is typically held in an escrow account managed by a third party, such as a real estate brokerage, law firm, or title company, until closing. At closing, the earnest money deposit is withdrawn from escrow and applied to the purchase transaction, usually as cash toward the down payment.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 ideal 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 a 5% earnest money deposit based on 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 inspection, and the title report is shown to be clear.

The mortgage is approved, and the home buyers go to closing, where their earnest money is applied toward the down payment and closing costs.

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 inspection or the buyer not securing 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 down payment?

No, earnest money is not the same as a down payment, although the buyer can credit the earnest money toward the eventual down payment at closing. Earnest money is paid upfront to show a buyer’s interest in a property. Down payments are cash applied to the purchase price at closing.

How much earnest money should I pay?

Earnest money deposits usually range from 1% to 3% of the home’s purchase price, but there are no set rules on the amount. A real estate agent can provide guidance based on your specific situation and local market conditions.