What an Earnest Money Deposit Is (and How to Protect It)

What is earnest money, how much is it, and how can you protect it?

Tips: making an earnest money deposit. Never give an earnest money deposit directly to the seller, obtain a receipt, authorize a release of your earnest money (or a pass-through) until your transaction closes, make the deposit payable to a reputable third party such as a well know real estate brokerage, legal firm, escrow company, or title company. Verify that third party will deposit the funds into a separately maintained trust account.

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The last thing any homebuyer wants to do is put down money to buy a home and then lose it, but it happens. Your earnest money deposit is an initial deposit that you make when you sign a purchase agreement. In some cases, you may make an earnest money deposit when you make an offer. Unfortunately, there are many ways to lose your earnest money deposit.

If you aren't sure how your deposit will be handled, ask questions at the time you make an offer. Ask to see the wording in the contract that guarantees the return of your deposit, and addresses how long it will take to get your deposit back. Not every purchase contract affords this type of protection.

Learn more about earnest money deposits, how they work, and how to keep yours safe.

Key Takeaways

  • Earnest money is an initial, good faith deposit that you make when you sign a purchase agreement, and it's typically 1% to 5% of the sale price.
  • When submitting your earnest money deposit, it's important to protect yourself by working with a reputable third party and getting a receipt.
  • Besides being scammed, you can also lose your earnest money deposit if you don't follow the terms of your purchase contract.

What Is an Earnest Money Deposit?

Earnest money is a good faith deposit that is part of the down payment, but it is not the same as a down payment. It is like the buyer saying to the seller, "Yes, I am serious enough about buying your house that I'm willing to put my money where my mouth is."

When a purchase contract is executed, it specifies how much money the buyer is initially putting down to secure the contract—the earnest money deposit—and how much money will ultimately be deposited as a down payment. The down payment is a portion of the home's sale price paid upfront rather than financed as part of the mortgage.

How Much Is an Earnest Money Deposit?

There is no specific earnest money deposit requirement, but potential homebuyers generally put down 1% to 5% of the purchase price as an earnest money deposit. Keep in mind that the amount of your earnest money deposit depends primarily on your marketplace and local custom.

Note

An experienced real estate agent can advise you on the typical earnest money percentage in your area.

Because there is no set amount, earnest money deposit amounts vary from market to market and across the country. In California, for example, deposits are generally 1% to 3% of the sales price. California buyers do not often put down more than 3%, since most sign a liquidated damages clause that limits the seller to 3% of the purchase price as damages in the event of a default.

If it's a seller's market, with many buyers fighting over limited inventory, it makes sense for the buyer to put down a larger earnest money deposit to entice the seller to accept the offer.

In buyer's markets, a larger earnest money deposit might entice a seller to accept a lower purchase price. It's often the market and local conditions that determine how much you should offer as an earnest money deposit.

How to Protect Your Earnest Money Deposit

When making an offer and submitting your earnest money deposit, it pays to be informed. While issues are rare, be sure you give the deposit to a trusted party. If anything seems fishy, talk to a trusted advisor. It's important to protect yourself and your money from potential scams.

In order to protect your earnest money deposit, keep the following tips in mind:

  • Never give an earnest money deposit directly to the seller.
  • Make the deposit payable to a reputable third party, such as a well-known and established real estate brokerage, legal firm, escrow company, or title company.
  • Verify that the third party will deposit the funds into a separately maintained escrow account.
  • Obtain a receipt.
  • In general, don't authorize a release of your earnest money until your transaction closes.

How You Can Lose Your Earnest Money Deposit

Typically, buyers can lose their earnest money deposit if they don't follow the terms of the purchase contract. For example, the contract may specify when inspections need to be completed and when a buyer can back out of a contract. If a buyer waits to get an inspection and then backs out of the contract after the deadline, they may lose the earnest money deposit.

However, laws vary from state to state, so be sure to read your contract. In California, for example, standard California Association of Realtors (CAR) purchase contracts allow for the return of the earnest money deposit to the buyer within a specified time period, should they elect to cancel the transaction.

If, at that point, the seller refuses to return the deposit without cause, they could end up paying a $1,000 civil penalty to the buyer. However, not every agent is a member of CAR in California. Other states may have state-mandated real estate forms.

How Escrow Can Protect Your Earnest Money Deposit

Holding your earnest money deposit in an escrow account can help protect you. For example, suppose your purchase agreement had a home inspection contingency. If the seller agreed to make the necessary repairs but never ended up making them, you could choose to back out of the contract.

Because your earnest money is held in the escrow account, the sellers do not yet have your money, and it could be returned to you.

Frequently Asked Questions (FAQs)

What is earnest money?

Earnest money is a good-faith deposit that shows the seller that a buyer is serious about purchasing the home. It is part of the down payment, but it is not the entire down payment.

What is the best way I can protect my earnest money deposit?

The best way to protect an earnest money deposit is to make it payable to a reputable third-party source rather than the seller directly. This could be a real estate company, escrow company, title company, or law firm.

How much is a typical earnest money deposit?

There is no set requirement for how much an earnest money deposit should be. But it is typically between 1% and 5% of the total purchase price. This may vary based on your local market.

Does earnest money get refunded?

If the home purchase is successful, the earnest money will be claimed by the seller. If the purchase contract falls through, it may be refunded to the buyer, depending on the circumstances.