You’ve probably heard of a down payment when buying a home, but there’s another payment you have to provide when you make an offer on a home called earnest money. If you’re wondering what is earnest money, it’s simply a deposit on a house made in good faith that shows a seller you’re serious about buying their home.
Though not always required, an earnest money deposit can increase the chances your offer is accepted — especially in a competitive seller’s market where you’re up against other buyers. Understanding the definition of earnest money and how much you should offer is key to navigating the homebuying process.
What is earnest money and what is it used for?
The definition of earnest money in real estate is a deposit that’s given upfront to a homeseller, representing the homebuyer’s promise, or good faith, to purchase the home. Think of earnest money as a deposit you put down for the home closing — though it isn’t always refundable.
Typically, earnest money is given when the buyer and seller sign the purchase agreement or sales contract, though it can also come with the home purchase offer. While there isn’t a set timeline for depositing earnest money, the purchase contract may stipulate when earnest money is due. In many cases, the deposit is required 24 to 48 hours after the contract is accepted and signed.
Once deposited, the funds must be held in an escrow account, typically until the closing transaction is complete. At that time, the deposit is applied to the buyer’s down payment and closing costs.
As for who gets earnest money, in most cases, it’s the seller, assuming the purchase contract goes through. However, there are some instances where earnest money may be returned to the homebuyer, such as if certain contingencies aren’t met or there’s a failed home inspection.
Is earnest money required? Why it's important
Earnest money isn’t always required. However, it’s common for a home seller to ask for an earnest money deposit as proof of how serious the buyer is about buying the house. Earnest money deposits can also offer some reassurance that if a buyer backs out before the home closing, the seller may be compensated for their time and any potential money lost when their listing was off the market.
As mentioned previously, putting down earnest money also can help you stand out in a competitive housing market, which can be another thing earnest money is used for.
For instance, if you want to live in an up-and-coming neighborhood and know that any home listed for sale will result in multiple bids, offering earnest money can help get your offer noticed. Even if your offer isn’t as high as others, a higher earnest money deposit can show that you’re more serious about following through with the purchase.
How much earnest money should you offer?
How much earnest money you should put down will depend on how much you want your offer to get accepted. Typically, between 1% to 5% of the purchase price is offered as earnest money when buying a house, though buyers can put down as much as 20%. For example, if you put an offer down on a home for $350,000, the earnest money deposit could be between $3,500 and $17,500.
In a competitive housing market, it may be smart to put down more earnest money to show how serious you are about the purchase. Make sure to budget carefully though, because you’ll also have to pay for a home inspection and other costs when it comes time to close. Before making your offer, speak to your real estate agent for guidance on how much earnest money to offer.
Is earnest money refundable?
Who gets the earnest money depends on how the purchase process plays out. The money can be returned to the buyer in certain cases, like if the seller cancels the contract or if a contingency — such as an appraisal, home inspection, or loan contingency — isn’t met during the closing process.
However, if the buyer backs out of the deal for reasons unrelated to any of the contingencies or terms stated in the purchase contract, then the seller has the right to keep the earnest money. For instance, if the buyer changes their mind about the home and decides not to move forward with the purchase, then they’ll have to forfeit their earnest money. If the buyer does move forward with the home purchase, on the other hand, then earnest money is part of the down payment or put toward closing costs typically.
Here’s a closer look at a few scenarios in which earnest money may be refundable to the buyer:
- The home fails the inspection: A failed home inspection is one of the most common reasons that buyers decide not to move forward with a home purchase. If the home inspection finds the home may have issues or need repairs, the homebuyer can either negotiate for these to be completed or request a credit for the approximate cost of repairs during closing. If the seller doesn’t agree, or if the home buyer isn’t satisfied with the home inspection results, they can back out of the deal and get their money refunded.
- The home is appraised for less than sale price: In some cases, a property may be overvalued and the selling price is way higher than the fair market value. If a home appraisal comes in for less than the sale price, the buyer can choose to back out and get the earnest money back if there’s an appraisal contingency in place.
- The buyer doesn’t get approved for a home loan: When a buyer puts earnest money down, they most likely aren’t yet approved for a mortgage at that stage. This means there’s a chance the mortgage underwriter could deny the loan. If there is a financing contingency in the purchase contract, the buyer can get their earnest money back if they are not approved for a home loan.
How to protect earnest money deposits
It’s important to protect your earnest money for a house, given it could be a large amount of money. Here are a few steps you can take to do so:
- Make sure you understand any contingencies included. Having contingencies protects the buyer and seller if either one decides to back out of the purchase. Make sure to read through the purchase agreement carefully to ensure all the contingencies you want are included and that you understand the circumstances in which you can back out of the deal and get your earnest money refunded.
- Keep up with your end of the contract. In most cases, the purchase contract includes a timeline detailing when each part of the closing process must be completed, including when you need to deposit your earnest money, complete the home inspection, and have the mortgage approved. If the buyer doesn’t keep up with these deadlines, the seller has the right to back out of the deal and keep the earnest money.
- Use an escrow account. Depositing the earnest money into a third-party escrow account ensures the money is safe until closing. In most cases, this account is held through an escrow company, legal firm, or title company.
If you need guidance on your earnest money deposit or any other part of the homebuying process, connect with a Finance of America Mortgage Advisor today.