What is earnest money when buying a home?

Home sellers want this show of good faith before they take their house off the market. (iStock)

Homebuyers making an offer on a house need to show the seller (or real estate broker) they're committed to completing the purchase and that they have the cash to fund a down payment. This is where earnest money comes in.

Earnest money is a deposit of good faith that you put down with your offer on a house that proves you have skin in the game. Assuming all contingencies are met, the money will be applied to your down payment and closing costs at settlement.

Here’s what you need to know about earnest money when buying a home.

What is earnest money?

Before taking their house off the market, a seller wants to see evidence that you’re truly dedicated to buying their home. Providing an earnest money deposit (EMD) demonstrates that you’re sincere, or “earnest,” about seeing the deal through. Many real estate professionals also refer to earnest money as a “good faith deposit.”

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Typically, after your offer on a home is accepted and you sign a purchase agreement, you provide your earnest money — in the form of a personal check, certified or cashier's check, or wire transfer — to a title company, which holds the money in an escrow account. In some cases, the seller’s real estate broker holds the money. Once the deal is finalized, the funds will be released at settlement and put toward your down payment and closing costs.

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Your earnest money provides a home seller protection because if the deal falls through under circumstances that are not covered by a contingency or a condition in your purchase contract, you’ll have to forfeit the money to the seller.

Can you get earnest money back?

If you back out of the deal for any reason or contingency that’s listed in your purchase agreement, you’ll get your earnest money back. But you could lose your deposit if you try to walk away for the wrong reasons. If these contingencies are included in your contract, they can impact whether you receive a refund of your earnest money:

  • Appraisal contingency. Most mortgage lenders require a home appraisal, where a professional appraiser will assess the home’s value. If the appraisal comes in lower than what you’ve agreed to pay for the home, you can walk away from the deal scot-free.
  • Home inspection contingency. If you find problems with the property during a home inspection, this contingency enables you to terminate the purchase agreement without any financial penalty.
  • Financing contingency. This contingency means that your purchase of the home depends on your getting a loan first. So, if your mortgage does not get approved, then you won't buy the house and you can take back your earnest money.
  • Title contingency. Before you purchase a home, your mortgage lender will require you to pay a title company to perform a title search of public property records to make sure there aren't any issues with transferring the property into your name. If there are title problems, such as liens against the property or other ownership claims, and you have a title contingency, you can void the purchase agreement and get your earnest money back.
  • Home sale contingency. If the home seller agrees to a home sale contingency, the sale of the property can take place only if you sell your current home by a specific date. If your home doesn’t sell within that time period, you can get void your purchase agreement without losing your earnest money.

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Protecting your earnest money

However, there are at least four instances where you could lose your deposit:

  • You miss a contract deadline. Most real estate purchase agreements set hard deadlines for when contingencies must be met. If you fall short, the seller may be entitled to your earnest money.
  • You don’t close on time. Typically, purchase agreements have a timeliness clause, which means the closing date for the sale is binding. If you can’t close on time, you’d be in breach of contract and may lose your deposit, unless the seller grants you an extension.
  • You get cold feet. If you have a change of heart and decide you no longer want to buy the home for personal reasons, you likely will not get your earnest money back.
  • You agreed to a non-refundable deposit. Offering a non-refundable earnest money deposit can sweeten the pot for a home seller, but it puts you at risk of losing the money if the deal falls through. Always make sure you protect yourself and your money by not agreeing to this unless you're positive it's a done deal.

What is an appropriate amount of earnest money?

A good faith deposit is usually 1 percent to 2 percent of the home’s purchase price. So, a $300,000 home would require an earnest money deposit of $3,000 to $6,000. However, this amount is negotiable between you and the seller (or real estate broker).

During the buying process, homebuyers may wind up making a larger deposit — think 4 percent to 5 percent — if you’re going up against other offers since handing over more earnest money can make your bid more attractive. And in some housing markets, sellers may even demand a larger deposit.

You’ll work with your real estate agent to determine how much earnest money to include when writing an offer on a house.