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Buying a home comes with a number of upfront expenses, including the down payment and closing costs. You’ll also need to pay an earnest money deposit, sometimes also called a good faith deposit, which shows the seller that you’re committed to making the transaction happen. Here’s what to know about earnest money, including how it works and how much you’ll need to put down.
What is earnest money in real estate?
Earnest money is an upfront payment, also known as a deposit, that demonstrates your intent to buy a home. By paying earnest money, you’re showing that you’re serious about the purchase.
“At closing, the earnest money deposit is credited toward the buyer’s purchase of the home,” says Lee Hunt, a senior loan originator with Motto Mortgage Simplified in Aiken, South Carolina.
How does earnest money work?
The purpose of an earnest money deposit is to show the seller that the buyer is serious about their offer by putting some “skin in the game,” says Bill Golden, a Realtor and associate broker with Keller Williams Realty Intown Atlanta. “It lets a seller know that the buyer intends to comply with the terms of the purchase and sale agreement.”
In most cases, you’ll need to deposit the earnest money within a day or two after your offer is accepted. The funds are then held by the real estate brokerage in an escrow account while you and the seller work to finalize the deal. In Georgia, the earnest money is held by one of the real estate brokers in the transaction, or sometimes by an attorney, Golden says.
Is earnest money required?
Earnest money is not required by law, but it is standard practice. “The majority of sellers demand it prior to accepting a contract,” Hunt says.
How much earnest money is enough?
The amount of earnest money you’ll need to pay is typically 1 percent of the home’s purchase price, but it can depend on the type of transaction and the nature of the broader market. On a $355,000 home, for example, you’d put down $3,550 as an earnest money deposit.
In a very competitive market, buyers may offer more to make their offer stand out, Golden says. Because most real estate agreements have contingencies to protect you as the buyer, handing over more earnest money to give you a leg up comes with relatively little risk. “If you pay strict attention to the dates and terms of all contingencies, a buyer’s earnest money is safe — as long as they don’t just try to walk away for a reason not included in the contract,” Golden says.
Is earnest money refundable?
“Earnest money is refundable under certain conditions, depending on how the contract is written,” Golden says. “Most contingencies in the contract — including the inspection or due diligence period, the financing and the appraisal contingencies — protect the buyer’s earnest money.”
So, if a deal falls through due to issues with the home inspection, for example, you’ll likely get your earnest money back. Here are some common contingencies that allow you to recoup your deposit:
- Financing contingency: This applies if the mortgage lender denies your loan and you can’t obtain financing for the home purchase.
- Appraisal contingency: This comes into play if the appraisal for the home ends up being lower than the amount of the mortgage.
- Inspection contingency: This protects you if the home inspection uncovers issues you didn’t know about, or problems you and the seller aren’t willing to address.
If all the contingencies have been met, however, and you still back out of the deal, you’re likely to lose your deposit to the seller. “Contracts are very specific about the process in which the earnest money would be disbursed in such cases,” Golden says.
Earnest money vs. down payment
Think of earnest money almost as a down payment on your down payment. Shortly after your offer on a home is accepted, you’ll make the earnest money deposit — those funds will typically be held in an escrow account until the sale is finalized. Then, at closing time, you’ll pay the remainder of the down payment (which usually ranges from 3 percent to 20 percent of the home’s purchase price). At this point, the earnest money you already paid is applied toward your full down payment amount.
How to protect your earnest money deposit
You can protect your earnest money deposit in two ways:
- Look out for signs of fraud: Do not give earnest money directly to a home seller, or wire the funds to the real estate brokerage, attorney or title company without first confirming the wire instructions have been sent from a legitimate source. You can do this by calling the brokerage or company at the correct phone number — sometimes, fraudulent emails contain phony contact information, so be vigilant when making the call.
- Understand your contingencies: Although some buyers might waive contingencies to make their offer more competitive, that can backfire if you need to walk away from the transaction. Have your real estate agent or attorney explain all contingencies and what your obligations are as the buyer, as well as the best way to waive a contingency if that’s the right strategy.
Earnest money is something like a small advance deposit on a home. As a homebuyer, putting down an earnest money deposit on a home shows the seller that you’re serious about buying their home, and that you are putting your money where your mouth is, so to speak. When the transaction closes, the earnest money gets applied toward the down payment.
You don’t get the amount back in cash, but it does go toward your down payment at closing time. So it’s not another payment in addition to the down payment, it’s more like a little bit of the down payment that you pay first, then the remainder is paid at closing.
If a real estate deal falls through because agreed-upon contingencies aren’t met, the buyer would likely get their earnest money back. However, if all contingencies are met and the buyer backs out anyway, the seller typically has the right to keep the earnest money deposit.