Everything You Need To Know About Earnest Money Deposits

If you describe a person as earnest, you essentially say that that person has intense conviction about something. If a salesperson is earnest, he is serious about securing your business. Just like a salesman working hard to close a deal, the earnest money is how homebuyers show a seller or a builder that they are committed to purchasing a property. Earnest money is a good faith deposit that goes towards your down payment at closing. While earnest money deposits usually go according to plan, there are certain circumstances where a transaction can fall through, and buyers can lose their earnest money. If you are shopping for homes, it’s crucial to understand earnest money and how it can be forfeited. 

The Basics Of Earnest Money Deposits 

How Much Is an Earnest Money Deposit?

When a home buyer executes a purchase contract, a provision states how much money the buyer is willing to put down to secure the contract and how much money will be deposited as a down payment. While there is no specific earnest money deposit requirement, homebuyers generally put down 1% to 3% of the purchase price as an earnest money deposit.

The amount of your earnest money deposit depends on your local market and home type. New construction homes, for example, may have higher earnest deposits.

Who Collects Earnest Money? 

Unfortunately, there are many horror stories of homebuyers losing their earnest money to scammers. Heed our warning now: Never give an earnest money deposit directly to the seller or a real estate brokerage. If something seems fishy, it probably is. The title or escrow company will hold your earnest money for you, but you should still verify that the funds were deposited into a separately maintained escrow account. Remember, don't authorize a release of your earnest money until your transaction closes.

How You Can Lose Your Earnest Money Deposit

There are many ways that a homebuyer can lose their earnest money, so it pays to be informed. Generally, buyers can lose their earnest money deposit if they don't follow the purchase contract terms. For example, a contract may specify when inspections need to be completed and when a buyer can back out of a contract. If a buyer fails to get an assessment and then backs out of the contract after a strict deadline, they may lose the earnest money deposit. However, laws vary from state to state, so be sure to read the fine print!

How Buyers Can Get Their Earnest Money Back

The buyer gets their earnest money back if the deal falls through due to contingencies listed in the contract. There are several types of contingencies, including a home inspection contingency, appraisal contingency, financing contingency, and a contingency for selling an existing home.

If a home is inspected by a professional and has significant repairs, a home inspection contingency can allow a buyer back out of the transaction. If the home is appraised at less than the sale price, buyers can get their earnest money back. If financing approvals fall through, a buyer may also walk away. Lastly, if a buyer with an existing home can't sell the home they own before closing, a contingency lets them back out of the deal with earnest money in hand.

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Bottom Line

Earnest money is a beneficial aspect of the home sales process for both buyers and sellers. Earnest money deposits are an act of good faith on the part of a buyer who is serious about purchasing a home. An earnest money deposit ensures that buyers don’t commit to buying multiple homes, only to leave sellers in the lurch. These deposits are secured in escrow accounts so that the seller doesn't receive the funds until closing day. The amount is also deducted from down payments, which can bide buyers' time to save up for the remainder of their down payment. Buyers and sellers must know when a buyer could lose their earnest money or get it back, so no one is surprised (in a bad way) during a transaction. Knowledge is power!

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