Why earnest money is required when buying a home
Earnest money is a good faith deposit made by the buyer during a real estate transaction. It signals to the seller that you’re serious about purchasing their property — and it also protects them in case the deal falls through.
You’ll pay earnest money after a seller accepts your offer. In exchange, the seller will typically take the home off the market to signal that they’re also committed to the sale.
Many first-time home buyers wonder how much earnest money to pay and whether or not they get it back. Keep reading to understand how earnest money works and the role it plays in the home-buying process.
In this article (Skip to…)
- How earnest money works
- How much is needed
- How to pay earnest money
- When earnest money is refundable
- Protecting your deposit
- Earnest money FAQ
How earnest money works
Earnest money is a sum of upfront cash that a buyer extends to the seller to show they’re serious about purchasing a property. If the deal closes, then the earnest money acts as a deposit toward the buyer’s down payment. But if the sale falls through, the earnest money is either refunded to the buyer or kept by the seller.
How the deal fell through will determine who gets to keep the funds. We go into this in more detail below.
You will need to hand over the earnest money check to escrow within one to two days of the seller accepting your offer. That’s why it’s good to have liquid funds available before making an offer. You don’t want to submit an offer, only to realize that you need time to sell stocks, borrow from your 401k, or get a gift from a relative.
How much earnest money do I need?
The amount of earnest money you’ll need varies greatly based on the housing market, the home purchase price, the area, and how many offers you expect the home to get. Your real estate agent or Realtor will be able to guide you on the specific amount of earnest money you’ll need.
“Typically, it’s a specific percentage of the home purchase price — usually around 3% to 5%,” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO.
As you might guess, hotter real estate markets and more desirable areas will require larger earnest money amounts. In low-cost areas with little competition, earnest money checks of $500-$1,000 are not unheard of.
How is earnest money paid?
Earnest money is a regular check, cashier’s check, or wire transfer from the buyer. It doesn’t go to the seller right away. Instead, it gets deposited into an escrow account with a real estate broker, title company, or attorney.
The seller considers earnest money “received” when they get word that funds are deposited with the escrow company. An escrow company is simply a third party that holds all money involved in the real estate transaction until the sale is complete.
Is earnest money refundable?
If a home sale falls through, the buyer’s earnest money may or may not be refundable. It depends on the reason the sale was canceled.
If you place contingencies (conditions) in the purchase agreement, and the home or seller doesn’t meet those agreements, you can get your earnest money back. For instance, say you agreed that the home would appraise for the sale price but it came in lower. If you had an appraisal contingency written in, you could back out of the deal and get your earnest money back.
Here are a few common contingencies that allow buyers to keep their earnest deposits.
- Appraisal contingency: When a home appraisal yields a lower valuation than the agreed purchase price, a buyer can either back out of the deal or negotiate a lower price point
- Inspection contingency: Similarly, buyers can make the sale contingent on a home inspection that does not reveal expensive-to-fix defects
- Financing contingency: A buyer’s offer can be dependent on qualifying for financing
- Existing home sale contingency: When the buyer needs to sell their current home to help finance the purchase of a new one
On the other hand, if you just don’t feel like buying the house anymore or back out for a reason not covered by a contingency, then the seller may have the right to keep your earnest money. Before you submit earnest money, make sure you are serious about buying the home.
How to protect your earnest money deposit
With all the details and tasks involved, it’s easy for potential buyers to switch to “autopilot” during the home-buying process. But remaining vigilant during the final stages of purchasing a home can ensure that you keep your earnest money should the deal fall through.
- Make sure all the contingencies are written into the terms of the contract. The purchase agreement between a buyer and seller should be in writing. This clarifies any misunderstandings and sets the terms of the agreement. Amendments to the contract are allowable, but make sure that every iteration of the agreement is in writing and signed by both parties
- Understand and adhere to the terms of the contract. In addition to having a firm grasp of all the contingencies, be sure to meet deadlines in a timely manner. Your agreement will establish a timeline for the completion of a home inspection, home appraisal, financing, and title search. Be sure to have everything ready by your closing date
- Hold funds in a third-party escrow account. Verify that your earnest money deposit is payable to a reputable third-party company and never send your deposit straight to the seller. It’s important that a professional escrow or title company control the funds to ensure impartiality
Earnest money FAQ
While buyers are not legally obligated to make a deposit, earnest money is customarily required in most real estate markets across the country. Not agreeing to offer a percentage of the home’s purchase price upfront could put a buyer at a disadvantage and jeopardize the transaction.
No, an earnest deposit is not necessary when refinancing your current home. Earnest money is a good-faith gesture buyers make to sellers when purchasing a new home. Your mortgage lender will not require any earnest money when you refinance. (However, you will have to pay closing costs on the loan.)
An earnest money deposit is typically held by either the seller’s real estate brokerage or in an escrow account with a third-party title company, bank, or legal firm. The home purchase contract should detail where the deposit will be kept.
Yes. Your earnest money does not just go away. Rather, it is applied to your down payment when you close the home loan. So you can think about earnest money as a piece of the down payment you’re putting up in advance.
If a sale goes through, the buyer’s earnest money is applied toward their down payment at closing. But buyers can also get earnest money back if the sale falls through for a reason covered by their purchase agreement. This could mean they backed out because issues were uncovered during the home inspection or the property appraised below its purchase price. The sales contract will list any contingencies that allow the buyer to back away from the purchase and keep their earnest deposit.
It’s possible to lose earnest money if the home sale falls through for a reason not covered by your contract. You may lose your earnest money if you cannot complete the real estate purchase by its closing date. Being unable to close, for whatever reason, is considered a breach of the purchase agreement, which results in forfeiting earnest money. Buyers commonly lose earnest money when they fail to meet deadlines or fail to secure a home loan.
While it depends on the situation, the buyer will typically keep the earnest money if they back out for a reason that is allowed by the contract, such as a home inspection contingency. On the other hand, the seller gets to keep the earnest money deposit when the buyer backs out because they’ve simply decided not to go through with the deal or they have waived contingencies.
How do I get approved to make an offer on a house?
If you’re ready to take the first step toward buying a home, you’ll need a mortgage preapproval. This initial loan approval tells you your budget and gives you the power to make an offer on a home. You can begin the preapproval process by connecting with a lender below.