Earnest Money: What Is It, and How Much Is It In Real Estate Deals?

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What is a 'earnest money'?

Earnest money is a deposit that a buyer gives to a seller to show that they are serious about buying something, like a new home. The money gives the buyer more time to get financing and do the title search, property appraisal, and inspections before closing. Earnest money can be seen as a down payment on a house, an escrow deposit, or money to show good faith.

TL/DR

• Earnest money is a deposit that a buyer puts down on a house they want to buy.
• When the earnest money is given, a contract is written up that spells out the rules for getting the money back.
• Earnest money deposits can be anywhere from 1% to 10% of the sales price, mostly depending on how much interest there is in the market.
• If a buyer breaks the terms of the contract, they could lose their earnest money deposit.
• But there are a few things that could be agreed upon that could keep the buyer from backing out of a deal and still letting them keep their earnest money.

Earnest Money In More Detail

Most of the time, earnest money is given when the sales or purchase contract is signed, but it can also be part of the offer. Once the money is deposited, it is usually kept in an escrow account until closing, when it is used to pay the buyer's down payment and closing costs.

When a buyer and a seller agree to sell a home to each other, they sign a contract. The contract doesn't force the buyer to buy the house, since the appraisal and inspection reports may show that the house has problems. The contract does, however, make sure that the seller takes the house off the market while it is inspected and valued. The buyer puts down an earnest money deposit to show that the offer to buy the property is made in good faith (EMD).

The buyer might be able to get the earnest money back if something goes wrong that was written into the contract. For example, the earnest money would be returned if the house doesn't appraise for the sales price or if the inspection finds a major flaw, as long as these things are written into the contract.

In general, the buyer gets the earnest money back if the seller backs out of the deal, but the seller gets the money back if the buyer backs out of the deal for no good reason.

How much are the amounts of earnest money?

The earnest money deposit can be negotiated between the buyer and seller, but it is usually between 1% and 2% of the price of the home, depending on the market. In hot housing markets, the earnest money deposit could be anywhere from 5% to 10% of the price of the home.

Most of the time, the earnest money deposit is a percentage of the sale price, but some sellers would rather have a fixed amount, like $5,000 or $10,000. Of course, the seller is more likely to take the buyer seriously if the earnest money amount is high. So, a buyer should offer an earnest money deposit that is high enough to be accepted but not so high that it puts more money at risk.

A seller may also ask for ongoing, periodic earnest money deposits from a potential buyer to show that they are still in good faith while they do their due diligence. For example, a seller might ask a buyer to put down a fixed amount of money every month for three months as a down payment. If the buyer doesn't meet any requirements for the earnest money deposit, the seller may be able to put the property back on the market and keep some of the earnest money to make up for any losses.

How do you pay earnest money?

Most of the time, earnest money is paid by certified check, personal check, or wire transfer into a trust or escrow account that is held by a real estate brokerage, law firm, or title company. The money is kept in an account until closing, when it is used to pay for the buyer's down payment and other costs.

It's important to remember that escrow accounts can earn interest, just like any other bank account. If the earnest money in the escrow account earns interest of more than $600, the buyer must fill out tax form W-9 with the IRS to get the interest.

There may be different rules about earnest money in different parts of the world. For example, the laws in Washington state and Minnesota define things a little bit differently.

Can I get my earnest money back?

Not all earnest money is refundable. The good news for buyers is that most of the time, if they act in good faith, they can get their earnest money back. Buyers usually get their earnest money back as long as the terms of the contract aren't broken and the deadlines for making decisions are met. Some of the most common situations in which buyers get their earnest money back are:

• If a home inspection finds major problems with a house that is for sale. Most of the time, the buyer can negotiate who will pay for the repairs or back out of the deal.
• If a home's appraised value is less than the agreed-upon price to buy it. The buyer can try to get the price of the item lowered or back out of the deal.
• If a buyer can't sell the house they already own (as long as this home sale contingency is agreed upon).
• If a buyer can't get a loan or financing (as long as this funding contingency is agreed upon).

Every situation is different, but in general, the seller gets to keep the earnest money if the buyer backs out of buying the house for reasons that aren't in the contract. For example, if a buyer just changes his or her mind and decides not to buy the house, the seller is probably allowed to keep the earnest money.

How to protect your earnest money

There are a few things that would-be buyers can do to keep their earnest money deposits safe.

• Make sure the contract includes options for financing and inspections. Without these, the buyer could lose the deposit if they can't get a loan or if a major problem is found during the inspection.
• Make sure the contract is in writing. The deal between a buyer and a seller should be written down. This clears up any confusion and sets the rules for how the agreement will work. You can always make changes to the contract, but make sure that every change is written down and signed by both parties.
• Read the contract, make sure you understand it, and follow its rules. For example, if the contract says that the home inspection must be done by a certain date, the buyer must meet that deadline or risk losing the deposit and the house.
• Use an escrow account to keep money safe. Do not send escrow money directly to the seller. If the other party has direct control over the money, they can keep it and not give it back to you even if you are owed a refund on your earnest money.
• Make sure that the deposit is dealt with properly. The deposit should be paid to a third party with a good reputation, like a well-known real estate agency, escrow company, title company, or law firm (never give the deposit directly to the seller). Buyers should always get a receipt and make sure the money will be held in an escrow account.

Earnest Money: An Example

Let's say Pedro wants to buy Ernestine's $1,000,000 home. So that the deal can go through, the broker sets up a $20,000 deposit in an escrow account. The next agreement, which was signed by both parties, says that Joy, who is living in the house right now, will move out within the next six months.

But Ernestine can't find a new place to live by the day she has to move. So, Pedro cancels the deal and gets the money he put down back. During this time, the escrow account has paid $599 in interest on the money that was put in as a deposit. Pedro does not have to fill out an IRS form to get the money because it is less than $600.

What is a "good faith" deposit?

When buying a house, earnest money is like a down payment. Most of the time, it's between 1% and 10% of the price of the home. Earnest money doesn't force a buyer to buy a home, but it does require the seller to take the property off the market during the appraisal process. Earnest money is put down as a sign of good faith that the home will be bought.

If a deal falls through, who keeps the earnest money?

The earnest money is returned if the appraisal doesn't go as planned, which was written into the contract. This could happen if the appraisal price is lower than the sale price, or if the house has a major flaw. Importantly, earnest money may not be returned if the flaw wasn't mentioned in the contract or if the buyer decides not to buy the house within a certain amount of time.

How can it be kept safe?

Prospective buyers can take a number of precautions to keep their earnest money deposit safe. First, buyers can make sure that defects, financing, and inspections are covered by the contingencies. This makes sure that the deposit won't be lost if a major flaw is found or if financing can't be found. Second, read the contract carefully and do what it says. In some cases, the contract will say that the inspection must be done by a certain date. To avoid losing the money, the buyer should follow these rules. Lastly, make sure the buyer works with a reputable broker, title company, escrow company, or legal firm to handle the deposit in the right way.

Do You Get Back Your Earnest Money?

Most of the time, a buyer will get their full earnest money deposit(s) back as long as they follow the terms of the contract and meet all of the deadlines they agreed to with the seller. If the buyer doesn't do what was agreed upon, the seller may be able to keep some or all of the earnest money.

How does earnest money get lost?

In a deal between a buyer and a seller, there are often a number of "what if" clauses that spell out the conditions under which a buyer can back out of the deal. This could happen if the home inspection fails, if the buyer can't get financing, or if they can't sell a separate property.

If the buyer decides not to go through with the sale for a reason other than what was agreed upon, the buyer risks losing the earnest money.

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