what is earnest money

What is Earnest Money and do you Need It?

If you’re looking at homes, you may hear the term ‘earnest money’ thrown around. It’s an important term to understand as it could make or break your ability to buy a home. Some sellers require it and others don’t, but it usually helps you win a bid on a home. 

Here’s why.

What is Earnest Money?

Earnest money is a deposit you put down before you buy the home. It’s a part of the sales contract and shows sellers that you are serious about buying the home. Some consider it a ‘good faith deposit’ or a way to show that you’ll do what it takes to follow through on the sale.

Sellers require an earnest money deposit because they take the home off the market. If you don’t close on the sale, the seller may keep your earnest deposit in exchange for the time he/she kept the home off the market.

How Much Earnest Money Must you Put Down?

There aren’t any requirements regarding a minimum earnest money deposit. On average, sellers want 1% – 3% of the sales price, however, many buyers put down a much larger deposit, sometimes as much as 10% of the sales price.

The more earnest money you promise, the more likely a seller is to accept your bid because it shows you are serious about buying the home and won’t back out at the last minute.

Can you get your Earnest Money Back?

Earnest money protects the seller like we said above. However, there are times when you (the buyer) can receive it back.

The earnest money protects the seller only if you back out of the contract for no reason. Let’s say you signed a contract, but found another home 2 weeks later and back out of the contract on the first home. The seller would keep your earnest money to make up for the time lost that they could have had the home on the market.

But, if you have contingencies in the contract, you protect your earnest money. For example, if you have an inspection contingency on your contract and the inspector finds major issues with the home, you can back out of the sale. You’ll keep your earnest money and be able to find another home.

Who Holds the Earnest Money Deposit?

The seller doesn’t hold your earnest money. A neutral third party called an escrow company (which is sometimes the title company) holds it. They don’t release the funds until all parameters of the contract have been met, one way or another.

If you close on the home, the earnest money becomes part of your down payment. For example, if you are putting down $20,000 and your earnest money deposit is $10,000, you’d only need another $10,000 to complete your down payment.

Bottom Line

An earnest money deposit may help you win a bid on a home if there are multiple interested buyers. Only enter a sales contract and put earnest money down when you’re serious about buying a home and talk to your attorney about including contingencies so you have a way out if things don’t pan out the way you hoped.

Written by the Mortgage Loan Center.