Earnest money is a deposit a buyer gives to a home seller to show that the buyer is serious about purchasing the property. Also called a “good-faith deposit,” earnest money accompanies an offer to buy a house. Earnest money is not mandatory, but it is very common.
While trying to buy a home can be overwhelming, especially if it’s your first time, understanding the meanings of different real estate terms will help. Let’s talk about the concept of earnest money, how much it’ll cost you, and what happens to your earnest money if your home sale doesn’t go through.
Definition and Examples of Earnest Money
Earnest money is a deposit you’ll make when you make an offer on a home. This is meant to show the seller that you’re serious about purchasing their property. And although earnest money isn’t necessarily a mandated part of a home offer, it is common enough in the United States that you’ll find it in nearly all real estate transactions.
The amount of earnest money you’ll offer depends on the seller; they may decide that they require a specific percentage of the list price or just a flat amount. Deposits of 1% to 2% of the purchase price are common. Depending on how the sale goes through—or doesn’t—earnest money will be distributed to the buyer, the seller, or back to you.
- Earnest money shows the seller a buyer’s intention to purchase their home.
- Earnest money is also called a good-faith deposit.
How Earnest Money Works
Earnest money usually accompanies an offer to purchase a home. This money is meant to show the seller that you’re genuinely interested in buying their property regardless of any contingencies you place on your offer. And unless you’re making an all-cash offer to purchase the house as-is, you will likely have contingencies built into your offer.
Common contingencies include selling your own home, securing financing, and successfully completing a satisfactory home inspection. Depending on how your contract moves forward, either you or the home seller will receive the earnest money. If you fail to follow through on your end of the bargain, that money may be forfeited to the seller. Let’s look at an example.
Let’s say you’ve made an offer on a home contingent upon a satisfactory home inspection and the seller accepts your offer. You have your financing, the home inspection goes off without a hitch, and you’re well on your way to closing when another home pops up on the market. It’s your dream home, and you can’t bear letting it slip through your fingers.
Make sure you know who is holding your deposit—it could be your broker, the seller’s broker, or even a third party, such as a bank or the escrow company that’s handling the transaction.
If you choose to back out of the contract for a reason that isn’t covered by your contingency—like failing the home inspection—the earnest money you’ve deposited will be distributed to the seller. In this case, a better home is not a good reason to cancel the contract and your good-faith deposit will be forfeited.
But what if this is your dream home and something goes wrong?
Let’s say the home inspection report indicates that the home’s foundation is cracked. As long as the deadline written in the contract for your inspection hasn’t passed, you have a few options. You can negotiate to have the seller repair the foundation or credit you the cost of the repair, or you can choose to back out of purchasing the home. Since the contingency covers a satisfactory home inspection, you are backing out of the purchase contract due to no fault of your own, and your earnest money is returned to you.
As long as things go according to plan, if you choose to leave the contract because of a covered contingency, the seller will sign the release of the earnest money deposit so that you can receive your funds. However, sometimes there will be disagreements and the seller can refuse to sign the required paperwork. In this case, the dispute will have to be settled in court.
But if the home inspection goes well, you secure your financing, and the home purchase moves ahead, earnest money is usually distributed according to your direction. You can choose to have it put toward the purchase price of the home or even have it disbursed back to you.
- Earnest money almost always accompanies an offer on a home.
- The earnest money deposit illustrates to the seller that you’re willing and able to purchase the property.
- If the home sale falls through, disbursement of the earnest money depends on your contract—it can go to either you or the seller.
- When the home closes, you can choose how you want your earnest money distributed.