What Is Earnest Money?

Key Takeaways

• As the name suggests, the earnest money is a deposit buyers make when purchasing a home.
• A written contract outlines the conditions for refunding the earnest money when it exchanges hands.
• In most cases, earnest money deposits represent between 1 and 10% of the sale price, depending on market interest.
• Earnest money deposits we may lose if a buyer breaches the contract.
• If certain contingencies apply, a buyer may be able to walk away from a deal but still keep all of their earnest money.

Understanding Earnest Money

A sales contract or purchase agreement usually receives earnest money when we sign it, but it can also be a part of the offer when submitted. Funds remain in an escrow account until closing when they go to closing costs and down payment.

Both parties sign an agreement for a buyer and seller to enter into a contract. However, the contract doesn’t compel the buyer to purchase the house, as a home appraisal and inspection may later reveal problems.

A buyer’s earnest money deposit (EMD) proves the buyer’s offer to buy the property was in good faith. The contract, however, ensures the seller removes the house from the market for inspection and appraisal.

As a result of something specified in the contract ahead of time, the buyer might be able to reclaim the earnest money deposit. The earnest money, for example, we would return if the house does not appraise for the sales price or when we found a serious defect during the inspection—provided these contingencies exist in the contract.

A buyer typically receives his earnest money back if the seller terminates the sale, while the seller receives it if the buyer terminates the sale unreasonably.

Total Amounts of the Earnest Money?

As a rule, on average, earnest deposits range between 1% and 2% of a home’s purchase price but can range as high as 5% and 10% in hot housing markets.

The earnest money deposit can be a percentage of the sales price or a fixed amount, such as $5,000 or $10,000. Buyers must offer an earnest deposit high enough to be accepted but not one that puts extra money at risk.

Therefore, the higher the amount, the more serious the seller will likely consider the buyer. As part of their due diligence process, a seller may also require periodic, ongoing earnest deposits from prospective buyers.

For example, the seller may need a buyer to make a monthly earnest deposit during the due diligence period of three months. Sellers may be able to bring back the property to the market if the buyer fails to make the required earnest money deposit and recover losses by keeping some of the earnest money.

Ways to Pay Earnest Money.

Certified checks, personal checks, or wire transfers are common ways to pay earnest money into trust or escrow accounts held by real estate brokerages, law firms, or title companies. A down payment and closing costs fall from the funds held in the account until closing.

Ways to Pay Earnest Money.

The buyer must fill out a W-9 form with the IRS to receive interest earned in an escrow account. Escrow accounts can accumulate interest just like any other bank account. Depending on the jurisdiction, we can define earnest money differently. For example, Washington state statutes may differ slightly from Minnesota statutes.

When Do You Lose Earnest Money?

Homebuyers sometimes forfeit their good faith deposits after a broken deal. Two scenarios may cause this to occur:

You are waiving your contingencies.

The mortgage contingency protects your earnest money if the mortgage falls through or the house is beyond repair. If you waive either or both of these contingencies, you give up your good faith deposit if the house doesn’t sell.

You are ignoring contract timelines.

There is usually a timeline within which the buyer has to complete the purchase process. If you fail to close the deal by the agreed deadline, you may be liable for forfeiting your good faith deposit.

What If I Change My Mind?

When a deal falls through for reasons covered by contingencies, the earnest will be refunded. Otherwise, it’s unlikely. The seller is entitled to keep your earnest deposit in case you change your mind late in the buying process due to reasons other than contingencies. This compensates the seller for the time, money, and effort in listing the property again.

Letting A Builder Keep Your Funds, You Should Consult An Attorney.

New home buyers usually pay an earnest money deposit of ten percent of the purchase price. There are times when builders will use these funds, and they do not remain in escrow. Before letting a builder keep your funds, you should consult an attorney.

It was an excruciating lesson that many builders went out of business during the real estate bust, leaving buyers with lost deposits.

Difference between an Earnest Money Deposit and a Down Payment Money.

There often needs to be more clarity among buyers as to the difference between an earnest money deposit and a down payment money they put down. These two distinct amounts come from the buyer’s pocket but have different purposes.

A good faith deposit is a way to ensure that the seller feels comfortable. It indicates that the buyer is serious about buying a home. It is important to distinguish a down payment from earnest money.

Specific Conditions Where Buyers Are Likely To Receive Their Earnest Money Back?

Generally, the earnest money is not refundable. The good news for buyers is that, in most cases, the earnest money is refundable as long as good faith exists. Buyers usually receive their earnest money back if they don’t break contracts or meet decision deadlines.

Here are some specific conditions where buyers are likely to receive their earnest money back:

• Inspecting the property before the sale may uncover issues.
• Buyers can negotiate a lower price or back out of a purchase agreement if the home appraises less than the agreed price.
• The buyer must agree to this home sale contingency if unable to sell their current home.
• A buyer needs help getting a loan/financial help.

When a buyer decides not to complete the home purchase for reasons not stated under the contract, the seller keeps his earnest money. If a buyer changes their mind and decides not to buy the property, the seller may be entitled to keep the earnest money proceeds.

Actions from Which You Can Protect Your Earnest Money Deposit

To protect earnest money deposits, prospective buyers can take various actions.

• Make sure contingencies for financing and inspections appear in the contract. The deposit will be forfeited if a serious defect occurs during the inspection or the buyer cannot get financing.
• Ensure contract terms are in writing. To clarify any misunderstandings and set a precedent for the terms of the agreement, a buyer and seller should have a written contract agreement, and it is possible to amend a contract. Still, it must be in writing and signed by both parties to be valid.
• Follow the contract’s terms, read them, and understand them. The buyer, for example, must meet a deadline for completing the home inspection, or they will lose the deposit and the property.
• Utilize an escrow account to hold funds. Sending escrow money directly to the seller may lead to their control of the funds and their refusal to refund your earnest money.
• Make sure that you handle the deposit appropriately. A reputable third party should receive the deposit, such as a real estate broker, an escrow company, a title company, or a legal firm. Always obtain a receipt from the seller and confirm that the funds are in an escrow account.

Example of Earnest Money

For example, suppose Tom wants to purchase Joy’s home for $100,000. To facilitate the transaction, he deposits $10,000 into an escrow account. Joy, currently living in the home, is expected to leave it within six months, according to the subsequent agreement signed by the two parties.

It turns out, however, that Joy cannot find a new place to live by moving day. Due to this, Tom cancels the transaction and receives his money back. During this period, the deposit money earned $500 in interest from the escrow account. Tom doesn’t need to complete an IRS form to retrieve the money since it is less than $600.1

What Is an Earnest Money Payment?

Generally, the earnest money is a deposit for buying a home. It usually ranges from 1 to 10% of the home’s selling price. In addition to representing good faith in purchasing the home, earnest money requires the seller to take the home off the market during the appraisal process. However, it does not compel a buyer to purchase the property.

When A Deal Fails, Who Keeps The Earnest Money?

There is a grantee of an earnest money refund in cases where the appraisal price does not match the sale price or there are significant flaws with the house that were predetermined in the contract.

An earnest money refund may not apply if the contract didn’t predetermine the flaw or if the buyer decided not to purchase the house within the agreed-upon timeframe.

How Can We Protect the Earnest Money?

Prospective buyers can take several preventive measures to protect their earnest money deposit. A buyer can ensure that contingencies cover defects, financing, and inspections, protecting the deposit.

It is also important to read the contract carefully and follow its terms. A contract may specify a deadline by which inspections must be conducted. Lastly, ensure that the buyer follows these terms to avoid forfeiture.

Finally, ensure the buyer uses a reputable broker, title company, escrow company, or legal firm to ensure the deposit lands properly.

Do You Get Earnest Money Back?

Buyers will usually receive the full amount of their earnest money deposit(s) if they adhere to the contract terms and meet all deadlines. If the buyer fails to comply with the agreement, some or all earnest deposit funds may return to the seller.

How Do You Lose Earnest Money?

When a buyer and seller enter a contract, contingencies usually specify the circumstances under which a buyer may revoke.

The buyer can lose earnest money if they decide not to proceed with the purchase for reasons other than those stipulated in the contingencies.

What You Should Know

Earnest money is usually issued when we sign a sales agreement or purchase contract. Once deposited, the funds remain in an escrow account until closing, after which the funds go to the closing costs and down payment of the buyer.

Both parties have to sign a contract to purchase a home. The contract may not obligate the buyer to buy the house since the valuation and inspection reports can reveal problems later.

Even so, the contract does mean that the seller will remove the property from the market. The buyer will pay a good faith earnest deposit (EMD) to ensure they are serious about buying.

Moreover, the earnest money is only sometimes refundable. A seller can keep earnest money if the buyer fails to follow the deadlines outlined in the contract or fails to proceed with the home purchase because of contingencies not mentioned in the contract.

Related Terms

Senior Citizens Saving Scheme (SCSS)

SCSS provides a daily income for seniors over 60 through its Senior Citizens Savings Scheme.

Escrow Agreement

The escrow agreement defines the terms and conditions that the participants must follow.

Provident Fund (PF)

India, Singapore, and other developing countries use provident funds as part of their mandatory retirement savings programs.

Joint Account

An individual and a couple may share a bank account called a joint account.

Land

A parcel of land is a property or a piece of real estate; however, we may assign a fixed spatial boundary for buildings and facilities.

Encumbrance

An encumbrance is a charge against a property filed by someone who does not own it.

Bottom Line

As part of the initial contract to transfer ownership rights, the buyer may have to deposit earnest money into an escrow account. A buyer can back out of the agreement for several reasons.

As compensation for the breach of good faith by the buyer, the seller may get to keep the earnest money.