When buying a house, you might not be the only one eyeing that dream home. To show you're serious about buying it, you can offer an earnest money deposit. This money goes to the seller in certain cases if you decide to walk away from the house.
Here's how earnest deposits work and what to look out for when agreeing to pay one.
Earnest money definition
An earnest money deposit is a deposit a prospective buyer puts down on a house to show that they're serious about buying it. Once the earnest deposit is paid, the seller pulls that house off the market and the buyer has time to get the house inspected and appraised.
The purpose of the earnest money deposit is to "safeguard the interests of the seller, as well as the buyer," says Deonte Cole, a real estate agent at Keller Williams Realty. If the buyer walks away from a property, the seller may get to keep the earnest deposit as compensation for their time and costs incurred now that they have to relist the property.
How an earnest money deposit works
The earnest money deposit works as a good-faith deposit. You pay it up front, as a way of showing sellers you're serious about a home. If you go through with the sale, it can go toward your closing costs and down payment.
The process from earnest money deposit to closing
The earnest deposit amount is agreed upon in the purchase agreement. Once this is paid, typically within three days of the agreement, it is held in an escrow account until the transaction is finalized.
If the house passes all its inspections and appraisals and the sale closes, the money put down as your earnest money deposit can go toward all the things you'll need to pay on closing day.
Conditions under which it's refunded or forfeited
If the buyer has contingencies in their contract, they may be able to back out while keeping their money.
If a buyer decides to move forward with a different house or walks away from a purchasing agreement for any reason beyond what was agreed upon in the contract, the buyer forfeits their earnest money deposit.
The importance of the earnest money deposit
Earnest money plays an important role in the homebuying process. Primarily, it serves the following two purposes.
Signaling buyer seriousness
Your earnest money deposit indicates how serious you are about a home. If you put down a large earnest money deposit, it tells the seller you're confident you're going to go through with the deal (so confident, in fact, that you're willing to risk a large chunk of change to do it).
Smaller earnest money deposits may not give sellers as much confidence in your offer and could make it hard to stand out from other buyers.
Protecting the transaction
Earnest money is also a sort of protection for sellers. It gives them money to fall back on if you back out of the deal and they're forced to start from square one again. It can compensate them for the time lost on the market, fees associated with re-listing and re-staging the home, and more.
Determining the earnest money deposit amount
An earnest money deposit isn't necessarily a requirement in purchasing a house, however, "it's seldom that you see a transaction where earnest money isn't on the table," Cole says. The earnest deposit amount is generally negotiable.
Factors influencing earnest deposit amounts
There's no hard and fast rule for calculating the earnest money deposit for property purchases. Though the typical deposit is 1% to 2% of a home's sale price, it can be as high as 10% of the property's value depending on a number of factors, including demand for the property, how long the home's been on the market, your interest in the house, and if the local real estate market is experiencing a seller's market, when demand outweighs supply.
In a buyer's market, where there is more supply than demand, the buyer may be able to get by with a smaller deposit. In competitive markets or with a home you really love, offering more is usually the better choice.
How to pay your earnest money deposit
You'll typically pay your earnest deposit right after your offer is accepted — usually within three days.
Common practices for making an earnest money deposit
You'll likely make your earnest money deposit via cashier's check, personal check, wire, or money order. It will then be deposited in an escrow account — a type of bank account that acts as a holding service until your deal is ultimately finalized.
Protecting your earnest money deposit
Your earnest money deposit is often thousands of dollars, so you'll want to take steps to ensure it's safe and, ideally, refundable if you have to back out of your contract. Here's how you can do that.
Ensuring refundability under certain conditions
As mentioned earlier, you can walk away from a purchase and get your earnest money deposit back under certain circumstances. However, these contingencies must be stipulated in your contract.
Here are a few common contingencies you might want to consider to ensure your earnest deposit is refundable.
Home inspection contingency: If a home inspection finds certain problems with the house, such as an infestation or mold, a home inspection contingency gives buyers the option to walk away from the property and get their deposit back. These contingencies can also give sellers the option to pay to correct the problems or give buyers the money to make repairs themselves.
Appraisal contingency: If an independent appraiser finds the value of the house to be lower than the property by an agreed-upon amount, a buyer can void the purchase agreement.
Title contingency: A title search confirms through public records that the seller is the actual holder of a property's title. This contingency ensures that if a title search finds issues with the property's ownership, the buyer can walk away.
There are many other contingencies that can be applied to a purchase agreement. Cole recommends working with your real estate agent to identify which contingencies you may need in your contract based on your situation, "and see if there's any criteria associated with earnest money that aren't in your favor," he says.
Selecting the right escrow service
Depending on your market's norms, you may be able to choose your own escrow services for earnest deposit management. And while fees matter, you should look at other factors when determining who to go with, too.
After all, your earnest money deposit is likely thousands of dollars, so you'll want to make sure you're choosing a good escrow service to safeguard it while you close on your home. Consider a company's experience in the industry, their reviews and reputation, and check with the Better Business Bureau to make sure there have been no serious complaints against them. You should also ask the company about its security measures. How do they protect not only your money, but also your private information and data?
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Earnest money deposit FAQs
What is earnest money?
Earnest money, or an earnest money deposit, is money you put in an escrow account when you're under contract on a home to show the sellers that you're serious about buying the property.
Is earnest money refundable?
Your earnest money deposit may be refundable under certain circumstances, but it depends on what your contract says. In some cases, you may not be able to get it back if you back out of the purchase.
What happens to earnest money at closing?
When you close on a home, your earnest money deposit will be used toward your closing costs or down payment.
How much is earnest money?
Local norms will dictate how much your earnest money deposit should be, but often it's between 1% and 2% of the purchase price.
How does earnest money work?
The earnest money deposit gives the home seller assurance that the buyer is committed to purchasing their home. Sellers take on some risk when they take their homes off the market, and earnest money can compensate for that if the buyer backs out unexpectedly.
