Earnest money is a deposit you make to show that you’re serious about buying a home.
To protect your earnest money deposit, you’ll want to include certain contingencies in your purchase agreement — such as contingencies for financing and a home inspection.
Once the purchase agreement has been signed, the seller’s real estate agent will place the earnest money in an escrow account until closing.
What is earnest money?
Pledging earnest money with your purchase offer is not a legal requirement to buy a home, but it is standard practice. It shows the seller that you intend to go through with the purchase as long as there’s nothing seriously wrong with the house.
Without an earnest money deposit, buyers could easily make offers on multiple properties since they’d have nothing to lose by backing out of the deal.
But this would put a lot of sellers in a tough position, and the real estate market wouldn’t function as smoothly.
Know the difference: Earnest money is not the same thing as a down payment. Both give you skin in the game, but earnest money shows the seller that you’re serious about the purchase, whereas a down payment shows the lender you’re serious about the purchase.
That said, you can usually apply your earnest money deposit toward your down payment, so you don’t have to worry about saving up enough money for both.
How much earnest money to put down
A typical earnest money deposit is 1% to 3% of the purchase price. For new construction, the seller might ask for 10%.
So, if you’re looking to purchase a $250,000 home, you can expect to put down anywhere from $2,500 to $25,000 in earnest money.
Several factors affect how much earnest money you’ll need to deposit:
- Demand: In a strong seller’s market, a large earnest money deposit can help make your offer stand out.
- Local customs: Ask your real estate agent what a typical earnest money deposit is in your area.
- What the seller will accept: If the seller doesn’t think your earnest money deposit is high enough to show you’re serious, they might not accept your offer. Consider what amount of good faith money would convince them to stop accepting offers from other buyers.
Learn More: How to Get a Mortgage (Home Loan)
What happens to your earnest money deposit
The seller’s real estate broker or agent will deposit your money into an escrow account. This means that neither you nor the seller can touch the money until certain conditions are met, which are spelled out in the purchase agreement.
Placing the money in escrow ensures that the seller gets the money if the buyer doesn’t hold up their end of the contract, and vice versa.
If the sale goes smoothly
If the home sale proceeds as expected, your earnest money deposit will help cover your down payment and closing costs.
If the sale falls through
A sale could fall through for many reasons. In some cases, you can lose your earnest money deposit:
- You get cold feet. If you decide to walk away from the home — whether it’s because you’ve found something better, decided it wasn’t a right fit, or had a sudden change in circumstances (e.g., you lost your job or came down with an illness) — the seller is entitled to keep your deposit.
- You provide a nonrefundable deposit. In a highly competitive market, you might offer a nonrefundable earnest money deposit to strengthen your offer — a major risk if you don’t have money to burn.
- A problem arises after a contingency deadline. To protect yourself, you’ll want to include contingencies in the sales contract that give you time to order an inspection, get a home appraisal, and secure your financing. You’ll waive each contingency after the deadline passes — and you won’t be entitled to an earnest money refund then.
How contingencies protect your earnest money
It’s common to include up to five standard loan contingencies in your purchase agreement. Each of these will give you the opportunity to get your earnest money back:
- Home inspection: If the home inspection reveals a major defect, you’ll have the freedom to walk away without losing your earnest money. Just make sure you complete the inspection before the contingency deadline.
- Home appraisal: You might want to move on if the home appraisal comes in significantly lower than the purchase price. In fact, unless the seller lowers the price, you might have to move on because lenders won’t approve you for a home loan if the appraisal comes in low.
- Clear title: This contingency, like the appraisal, is connected to the financing contingency. You must purchase a lender’s title insurance policy to protect the lender against competing ownership claims to the home. If the title company you hire finds a problem it can’t easily resolve, a title contingency allows you to exit the agreement without losing your earnest money.
- Mortgage financing: It’s smart to get pre-approved for a mortgage before making an offer so you don’t waste your time or the seller’s. Still, final approval will depend on the property being in good shape, having a clear title, and appraising at or above the purchase price.
- Home sale: If you need to sell your current home before you can buy a new home, your offer might include this contingency. However, the seller might not accept an offer with this contingency. It puts them in a bad position: They’ll have to wait for you to sell the home and might have to pass on other offers in the meantime. Consider a bridge loan to avoid this problem.
Check out: Contingent Offer: Should You Use One to Buy a House?
