What is Earnest Money?

There it is, the perfect home to raise a family. It even has a pool and a swing set. Since it’s a really nice property in a good school district, and the market is hotter than the desert sun. 

Buyers must be ready to not only offer a fair price, but also a “good faith” deposit called earnest money. 

Let’s look at what earnest money means, how much you should put down, and how it’s used. 

What is earnest money?

Earnest money, also known as a “good faith” deposit, is a deposit to show the seller you’re serious about the purchase. 

It is not a down payment on the home. Although this money can be used toward the down payment once the deal is complete. 

Earnest money is not required to buy a home. But in a hot market where sellers are getting loads of offers, buyers should show “good faith” by making an earnest deposit. Your deposit could convince sellers to not accept other offers.

Depending on the contract, earnest money can protect the seller. It compensates them for the time the house is off the market if purchase deal falls through.

An earnest deposit is put into an escrow account as part of the purchase agreement until the deal is completed. 

Depending on the contract, and if everything goes okay with the sale, the money will  be used toward the down payment on the home or for closing costs. 

What should be in your contract regarding earnest money? 

Earnest money protects the seller in the event that a buyer backs out. But the contract protects both the seller and buyer by setting terms that define when a refund of this deposit should take place. 

First-time home buyers might not be familiar with this concept and should consult with their loan officer for clarity. 

Basic information that should be outlined in this contract includes the following. 

• Buyer and seller details — to establish which parties are taking part in the sale 
• Property details — including purchase price, financing, lead-paint disclosure, closing costs, and warranties
• Escrow agent information — both parties need to decide on an escrow agent. In case there’s a problem and the sale falls through, the escrow agent will be the one distributing the money to the proper party. 
• Amount of deposit — there is no rule about how much earnest money has to be offered. The contract will note the amount of the deposit being held.

Additionally, buyers must protect their money by defining contingencies in the purchase agreement that allow them to walk away without penalty if certain criteria are not met. 

Common contingencies include a surprise defect revealed during the home inspection or the home is appraised for less than the agreed-upon sale price, among many others. 

How much earnest money should you put down?

Usually, buyers put down between 1% to 5% of the accepted offer. But in some markets that go as high as 10%. This figure depends on several factors.

Some things that can change the amount are the current state of the housing market and how many offers the seller is fielding.  

More money is often required in competitive “seller’s markets” saturated by eager buyers. Sometimes a higher “good faith” deposit is recommended in order for the seller to begin even negotiating with the buyer. 

In hot markets where a bidding war for desirable properties may break out, often the buyer offering the most earnest money will have a leg-up over other buyers. Therefore, in these markets, earnest deposits should be part of the buyer’s purchasing budget. 

The seller may also have an idea in their head about how much should be in “good faith” to consider the offer seriously, and may not accept offers from folks they think are low-balling them. 

Is earnest money refundable?

The short answer is yes. But not always. 

The terms of the purchasing contract will go a long way in answering this question. But there are several instances where buyers would lose their deposit. 

Again, it’s up to the buyer to ensure they have outs through contingencies before signing the purchase agreement. 

Backing out of the deal — getting cold feet or finding a better property after you submitted a purchase agreement — may cause a forfeiture of the earnest money deposit. 

Missing deadlines set by the contingencies in the purchase agreement could also cause the buyer to lose their earnest money. 

But for the most part, while earnest money is designed to protect sellers, many state laws make it difficult for them to keep the money outright. Talk with your real estate agent or loan officer to learn how it works where you live. 

Working with an experienced and trusted real estate agent will lower the chances of making mistakes and losing your deposit. 

Can earnest money go toward your down payment or closing costs?

Absolutely! In fact, this is the usual practice. Closing costs include:

• Attorney fees
• Title fees
• Survey fees
• Transfer fees
• Loan origination fees
• Appraisal fees
• Document preparation fees
• Title insurance 

An earnest money deposit can also go towards the down payment. It just depends how the contract was written when the purchasing process began and the earnest money was put into escrow. The escrow agent is the one who will distribute the money at closing.

Get ahead with Homefinity

Mortgage pre-approval and an earnest money deposit in your original offer will most likely put you at the front of the line in competitive markets. 

Even in cooler markets, earnest money is usually highly recommended to show sellers you are serious enough about buying their property.

At Homefinity, an experienced loan officer is always standing by to answer any question about earnest money or home mortgages. 

Contact us today and put yourself ahead of the competition of other buyers.

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