Real Estate Guide: What Is Earnest Money?

Earnest money is an offer you make in the early stages of the home buying process to indicate to the seller you’re serious about buying their house. Earnest money is not the same as a down payment; it’s more of a placeholder to show the home seller you’re excited and confident about the real estate transaction that you’re offering some of the funds upfront. Once you and the other party meet the terms of the sales contract, you can pull the money—usually from an escrow account—to help cover your down payment and closing costs.

The amount of earnest money you should deposit depends, at least in part, on various forces of the housing market. While some sellers may prefer a fixed amount of money—rather than operating off of percentages—it remains far more likely you’ll determine how much earnest money to put down based on a proportion of the home value. Competitive markets will require higher amounts, but a good starting point may be around 1–5 percent of the sale price.

Before you put earnest money on the table, it is advisable that you ensure this is the home for you. In all but a few cases, the seller will not have any obligation to return your deposit should you back out. Still, in some circumstances, you can get your money refunded, including:

• Appraisal contingency: The seller has, in all likelihood, done their best to list an accurate purchase price for their home; however, some sellers may attempt to try to get more than it’s worth. Whoever is lending you the money for this purchase will want to guarantee they’re loaning you the appropriate amount—in other words, they’ll conduct an appraisal to make sure the seller has priced the home appropriately. If their appraisal of the property comes in lower than the purchase price in your initial contract, you can back out of the deal and get your earnest money back.
• Home inspection contingency: If a home inspector discovers mold, determines that the house needs repairs, or finds anything that makes the house uninhabitable, you can exit the contract with your money in hand.
• Mortgage financing contingency: The vast majority of people will require mortgage financing to pay for their houses and, occasionally, you can hit a snag in securing that much money even very close to the finish line. If that’s the case, you can get your earnest money back. Still, it’s important to read the fine print of any contract you sign—there may be specific stipulations about when this contingency applies in one that doesn’t in others.

If you plan to hand earnest money over to a seller, you want to ensure you’re making the right decision and doing so in a safe way. Here’s a step-by-step guide that may help you achieve that sense of security:

• Assess the market. Housing markets vary from city to city. Moreover, the individual neighborhoods in those cities will all encompass their own mortgage rates and sales prices. A competitive market will likely require a higher earnest money offer—to outbid other buyers—than one in which fewer people are vying for their ideal new home and price.
• Cover your bases. If affording your new house requires you to refinance or sell your current home, it’s typically to your benefit to finalize those details prior to buying your new home since an earnest money deposit works best when you can offer it with certainty. For example, if you’re worried your credit score may jeopardize your financing as a home loan borrower, it’s a good idea to resolve real estate matters pertaining to your current home well before you make your offer to bid on a house.
• Be confident in your decision. While certain contingencies allow you to back out as a buyer once you send your deposit, you should operate off the assumption that you won’t get your earnest money deposit back. Outside of those stipulations, if a buyer fails to uphold their end of the contract or has a change of heart, the seller gets to keep the earnest money. Buying a new home allows for a contemplative approach in the early stages, but once you’re here at the purchase contract stage, you should feel as certain as possible that this is the home for you.
• Work with a real estate agent. First-time homebuyers especially can benefit from working with a realtor to help navigate the real estate market. Even for people who have gone through this process before, realtors can ease the stresses of the home-buying process. Real estate agents can help you find your way through each step of a real estate transaction, from the moment you put down your initial earnest money deposit all the way to the finish line when the buyer or seller pays the closing costs.
• Ensure protection through contingencies. Some agreements will provide opportunities to get an earnest money refund if the deal falls through under certain circumstances. The terms of the contract should include the aforementioned contingencies for your security should anything happen as a result of the home sale process that’s out of your control.
• Let a third party hold the money. Unlike many other deals and purchases, a real estate transaction should never happen directly between a seller and buyer. A brokerage, title company, or escrow company should hold your earnest money deposit to ensure that the money you offer in good faith is also handled in the same way.
• Proceed to the next steps. Now is the time to make sure all the contingency hurdles have cleared. Has the house passed inspection? Is your financing secured? Is the appraisal consistent with the price provided at the outset? If the answer to all those questions is yes, then your good faith money has helped toward your new home.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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