Earnest money, also known as a “good faith deposit,” is a sum of money paid upfront when you make an offer on a new home. Though not legally required, it’s become a standard practice in the real estate industry. When you enter into a purchase agreement, the seller takes the house off the market as a sign of their sincerity and you put up a small amount of cash as a sign of your sincerity. It demonstrates you’re serious and willing to proceed with the purchase. If the deal falls through, the money compensates the seller for their lost time and effort.

How Does Earnest Money Work?

An earnest money deposit is typically 1-3 percent of the home’s purchase price, though in a competitive market, you may be asked to put down more, as much as ten percent. Earnest money isn’t given directly to the seller. Instead, it’s placed into an escrow account, typically managed by a title company, real estate attorney, or mortgage lender, often the one responsible for overseeing the rest of the homebuying process.

Once you’ve signed the purchase contract, the earnest money is normally due within three days - either in the form of a personal check, certified check, or wire transfer. The money sits in escrow while you conduct your due diligence, which normally takes 3-5 weeks.

If you’re purchasing a luxury home, where the due diligence process can last for several months, the seller may not only require a larger amount of earnest money, but ask you to deliver it in monthly installments as well. In these cases, if the buyer misses a payment, the seller is entitled to keep the money deposited up to that point.

Is Earnest Money Refundable?

Under certain circumstances, earnest money is refundable. The terms are included in the purchase agreement. If the seller pulls out of the deal, for instance, the money is returned to you. There are also contingency clauses that allow you to back out of the deal and keep the money you’ve put down. Buyers are entitled to add as many contingencies as they’d like, though it discourages sellers, since it makes the deal more likely to fall through. To protect their clients, realtors typically rely on three contingencies.

• Financing Contingency. If your mortgage application is rejected, either due to a change in your financial situation, a falling credit score, or issues with the property, the escrow company will refund your earnest money.
• Appraisal Contingency. Home appraisers provide an objective, professional evaluation of a house’s value. After considering its size, age, and condition, they compare it to similar properties recently sold in the area and determine its worth. If they estimate its worth is less than its sale price, buyers have the option of exiting the deal with their money.
• Home Inspection Contingency. During a home inspection, a licensed professional examines the roof, walls, floor, and foundation of the property for structural weaknesses. They also test the plumbing, electrical, and HVAC systems, as well as basic safety features such as smoke alarms and carbon monoxide detectors. If they discover serious problems that weren’t disclosed by the seller (e.g. mold, water damage, pest infestation, cracked foundation, code violations), buyers have the option to back out.

These contingencies have to be included in the purchase contract before the earnest money is put into escrow. Otherwise, the seller isn’t obligated to turn the money back over to you, regardless of the state of the property or your financing.

Earnest Money Vs. A Down Payment

First-time home buyers are often unfamiliar with the difference between earnest money and a down payment. An earnest deposit is paid when you sign the sales contract, at the start of the real estate transaction. By contrast, a down payment is used to help you secure a home loan. Though you have to prove it exists with financial documentation before you get pre-approved and receive financing, the money remains in your account until the process is finished.

In most cases, your earnest money eventually becomes part of your down payment. Once closing is complete, the rest of the down payment is wired to the same escrow account as your earnest money, so your escrow company can pass it on to the seller. Earnest money can also be used to cover your closing costs. It all depends on the size of your loan and how much earnest money you put down.

Your Home Mortgage Experts

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