What Is Earnest Money?

What Is Earnest Money?

Let me explain earnest money to you directly: it's a deposit you pay as a buyer to a seller to show you're serious about buying a property, like a new home. Think of it as a deposit on the house, an escrow deposit, or good faith money.

Understanding Earnest Money

In most situations, you deliver earnest money when you sign the sales contract or purchase agreement, but it could also come with your initial offer. Once you deposit it, the funds usually sit in an escrow account until closing, where they get applied to your down payment and closing costs. This gives you, the buyer, extra time to secure financing, do a title search, get a property appraisal, and conduct inspections before everything finalizes.

When you decide to buy a home from a seller, you both enter a contract. That contract doesn't force you to buy if the appraisal or inspection uncovers issues with the house. But it does make the seller take the home off the market while you inspect and appraise it. To prove you're serious, you make this earnest money deposit (EMD).

You might get your earnest money back if something specified in the contract goes wrong. For example, if the house doesn't appraise at the sales price or the inspection finds a major defect, and these are listed as contingencies, you can reclaim it.

Remember, earnest money returns to you if the seller ends the deal, but the seller gets it if you unreasonably terminate the deal.

How Much Are the Earnest Money Amounts?

You and the seller negotiate the earnest money amount, but it typically ranges from 1% to 2% of the home's purchase price, based on the market. In competitive housing markets, it could climb to 5% or even 10% of the sale price.

Sometimes sellers want a fixed amount, like $5,000 or $10,000, instead of a percentage. The higher the deposit, the more serious the seller sees you as a buyer. So, offer enough to get accepted, but don't risk more than necessary.

A seller might require ongoing earnest deposits to keep showing good faith during due diligence. For instance, you could make monthly deposits over a three-month period. If you miss those, the seller could put the property back on the market and keep some of the money to cover losses.

How Is Earnest Money Paid?

You usually pay earnest money by certified check, personal check, or wire transfer into a trust or escrow account managed by a real estate brokerage, legal firm, or title company. The funds stay there until closing, then apply to your down payment and costs.

Escrow accounts can earn interest, just like bank accounts. If the interest on your earnest funds exceeds $600, you'll need to fill out IRS form W-9 to receive it.

Different places have varying rules on earnest money—Washington state laws differ slightly from Minnesota's, for example.

Is Earnest Money Refundable?

Earnest money isn't always refunded if the deal collapses. But if you follow the contract and don't miss deadlines, you can usually get it back. Conditions for refunds include material issues from a home inspection, where you can negotiate repairs or back out; a low appraisal, letting you negotiate price or exit; inability to sell your current house if that's a contingency; or failure to get financing if specified.

Every case varies, but generally, the seller keeps the money if you back out for reasons not in the contract, like a change of heart or choosing another property.

Protecting Your Earnest Money Deposit

You can take steps to safeguard your earnest money. Include contingencies for financing and inspections in the contract—without them, you risk losing the deposit if you can't get a loan or find a defect.

Get all contract terms in writing to avoid misunderstandings and set clear expectations. You can amend contracts, but make sure every version is written and signed by both sides.

Read, understand, and follow the contract terms. If it says the inspection must happen by a specific date, meet it or risk the deposit.

Use an escrow account for the funds—don't send money directly to the seller, as they could withhold it even if you're entitled to a refund.

Handle the deposit properly by paying to a reputable third party like a known brokerage, escrow company, title company, or legal firm. Verify the escrow setup and always get a receipt.

Earnest Money vs. Down Payment

Earnest money and down payments both play roles in real estate deals, but they're different. Earnest money proves you're serious about your offer, while the down payment is a bigger sum to secure your loan and acts as collateral for the lender.

The down payment size depends on the mortgage type, lender rules, and your finances. In riskier deals, sellers might demand a higher down payment, say 20% instead of 10%. It lowers what you borrow, improving your loan terms. Earnest money can count toward the down payment or be returned at closing.

Example of Earnest Money

Suppose you want to buy a $100,000 home from a seller. The broker sets up a $10,000 deposit in escrow. The agreement says the seller, still living there, will move out in six months.

But if the seller can't find a new place and doesn't move, you cancel and get your deposit back. If the escrow earned $500 in interest—under $600—you don't need an IRS form for it.

Explain Like I'm Five

Buying a home takes time, and lots can go wrong from offer to close. Earnest money is your deposit to show you're serious, but it lets you back out if big problems pop up.

If inspection or appraisal finds issues, you get the money back. But if you cancel without a good reason, the seller keeps it for the trouble of taking the home off the market. Agree on terms when you deposit it.

Frequently Asked Questions

What is earnest money? It's basically a deposit to buy a home, usually 1% to 2% of the sale price. It doesn't force you to buy but makes the seller remove the property from the market during appraisal.

Who keeps earnest money if the deal falls through? You get it back if contract-specified issues arise, like a low appraisal or major flaw. But not if you back out for unlisted reasons or miss deadlines.

How can you protect earnest money? Include contingencies for defects, financing, and inspections. Read and follow the contract, and use a reputable firm for escrow.

Do you get earnest money back? Yes, if you comply with the contract and deadlines; otherwise, the seller might keep some or all.

How do you lose earnest money? If you back out for reasons not in the contingencies, like not proceeding without a stated cause.

The Bottom Line

When you and a seller agree to transfer property, you often deposit earnest money into escrow. You both decide when you can back out without losing it. But if you break the contract or miss deadlines, the seller keeps it as compensation.