What Is Earnest Money?
Earnest money, or good faith money, is an upfront deposit that a buyer applies to the purchase of a home when delivering an initial “offer to purchase” contract to a seller. Earnest money for a house or real estate purchase plays a special role, so it’s especially important to understand the rules that typically govern these types of financial transactions. We’ll explore the differences between an earnest money deposit vs a down payment on a house — and shed some light on the ways earnest money is used to help secure a home in today’s real estate market.
Is Earnest Money Required?
Most sellers require earnest money. And that earnest money can play a key role when homes are receiving multiple bids. Sellers are more likely to accept a bid with the most favorable financial profile — often with a large earnest money deposit — because deals like these have a better chance of closing on time, and are more likely to be fully funded.
But when a big investment like the sale of a home is on the line, sellers need assurances that the buyer is serious. That’s because the home’s multiple listing service (MLS) status usually changes to “under contract” when sellers accept an offer to purchase. And that can push other potential buyers and their brokers to shop elsewhere. Those still in the market for a home would rather place their bet (or their earnest money) on a home that’s still accepting offers.
Can You Buy a House Without Earnest Money?
Yes, you can purchase a home without earnest money — but your deal may be at a greater risk of falling through. If you find yourself asking, “What if I don’t have earnest money?” you have options. For example, in your offer, you can request a waiver of earnest money. Have your real estate agent write up the waiver contract and submit it through normal channels. Although it’s less likely the seller will agree, they may opt for a waiver of earnest money offer when market conditions aren’t in their favor.
How Much Earnest Money Should I Put Down on a House?
You should put down anywhere from 1 percent to 2 percent of the purchase price in earnest money. It will be held in an escrow and applied to the rest of your down payment at closing. If your offer to purchase is $250,000 your typical earnest money amount would range from $2,500 to $5,000. In your offer, you specify the amount of earnest money that goes into escrow should the seller accept the offer.
When Is Earnest Money Due?
It’s usually due within three days of a signed and accepted offer. The money can be wired to an escrow account, or a cashier’s check can be delivered to the seller’s agent. It’s really important to get that money to the seller as soon as your offer’s been accepted. That way, you’ll help to lock in the agreement, shift its MLS status to “under contract,” and you’re one step closer to landing that home.
Earnest Money Factors to Consider
There are a lot of market factors to review when making an offer, so getting a feel for how much earnest money you should put down is key. Ask your real estate agent for their recommendation on the amount of earnest money to propose. Here are a few items to keep in mind:
Home price. Be sure that the earnest money in the offer is adequate to reflect a small percentage of the home’s asking price.
Market trends. Depending on the region, homes may only be on the market for a few days before offers are even entertained. When homes are going under contract quickly, you may need to make your offer more attractive with a bigger earnest money deposit.
Your interest in the home. If you really want the home, you’ll have to act quickly to view and assess it — and verify that it’s right for you. Then make your offer.
Is Earnest Money Refundable?
Earnest money is refundable under the right circumstances. If your offer to purchase includes the rules and contingencies that carefully define how and when earnest money is to be handled, you’ll have a better chance of getting your earnest money back if an agreement is broken. Contingencies afford you the ability to exit the contract with your earnest money, usually when an unforeseen event arises during the closing process.
Typical contingencies that allow an earnest money refund:
- If the home fails the inspection
- If the home doesn’t appraise correctly
- Financing is denied or delayed
- If title search issues arise
When Can a Seller Keep Earnest Money?
The seller is allowed to keep the earnest money when the buyer breaks a key part of the agreement. It’s important to pay particular attention to contract contingencies that impact when default or a breach of contract occurs.
The seller will require a legitimate reason to break the contract. When the buyer doesn’t meet a deadline, like failing to get the home inspected within an agreed-upon amount of time, the seller can keep the money and nullify the contract.
When Is the Buyer Allowed a Refund of the Earnest Money?
The buyer is allowed to reclaim their earnest money when the seller fails to deliver on a promise in the contract. If they don’t hold up their end of the deal, the buyer can back out of the agreement and will be refunded the earnest money.
Suppose the seller agreed to replace windows before closing. But upon the final inspection, the buyer finds the windows were not replaced as promised. The seller would then have to forfeit the earnest money back to the buyer and the contract to purchase can be voided, or other arrangements can be made between the seller and buyer. Perhaps the seller will offer to put $5,000 in escrow to pay for the replacement of the windows. If the buyer agrees, they can move forward and close.
Do You Get the Earnest Money Back at Closing?
You do get your earnest money back at closing. After it’s released from escrow, earnest money becomes cash you use to purchase the property. There, your earnest money is typically applied to the down payment. But don’t confuse down payment and closing costs — they’re separate moneys that each help pay for the purchase of your home, but in separate ways.
Managing earnest money and making an initial offer on the purchase of a home is best done with the advice of a real estate broker and by carefully watching local market trends. While you’re weighing out your earnest money options, remember to check in with your American Family Insurance agent and secure a homeowners quote. Your agent can help you find the coverage you need to protect your finances and your new home.