Updated April 2, 2021 . AmFam Team
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 whether it is required, when it’s due and shed some light on the ways earnest money is used to help secure a home in today’s real estate market.
Many potential homebuyers ask what the purpose of earnest money is and how exactly it works. Earnest money works by offering a portion of cash up front — usually 1-2% of the purchase price — as incentive to pull the property from the market and consider your offer exclusively. Earnest money also works by financially protecting the seller if the buyer does not go through with purchasing the home, as the seller is usually the one who gets earnest money if that occurs.
Not exactly, but shopping without an earnest money deposit on the table may limit your options. Sellers are more likely to accept a bid with the most favorable financial profile — often those with earnest money deposits — because deals with earnest payments have a better chance of closing on time, and provide greater assurances to the seller.
Sellers need these assurances because the home’s multiple listing service (MLS) status usually changes to “under contract” when an offer to purchase is accepted. Understandably, that can push other possible buyers and their brokers to shop for properties still accepting offers.
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.
Generally, a buyer will deposit 1% to 2% of the purchase price in earnest money, but that amount can be higher depending on your agreement. It will be held in an escrow account 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.
Earnest money is usually due within three days of a signed and accepted offer. The earnest money check can be wired to an escrow account, or delivered to the seller’s agent. It’s important to get that money to the seller as soon as your offer has been accepted. That way, you’ll help to lock in the agreement, shift its MLS status to “under contract,” and take one step closer to landing that home.
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. Your real estate agent can recommend the typical earnest money amount to offer based on several factors. Here are a few items to keep in mind:
Be sure that the earnest money in the offer is adequate to reflect a small percentage of the home’s asking price.
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.
If you really want the home, you’ll have to act quickly to view and assess that it’s right for you. Then make your offer.
If you really want to purchase a given home, it may be wise to aim high. By presenting five percent or more of the asking price in earnest money, you may be able to get the seller’s attention.
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:
The seller may keep the earnest money when the buyer breaks a key part of the agreement. It’s important to pay particular attention to contract violation details such as breach and defaulting terms.
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.
The buyer can 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 and, upon 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 might be voided pending any other arrangements made between the seller and buyer.
For instance, 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.
Yes, you do get your earnest money back at closing. After being released from escrow, earnest money becomes cash you use to purchase the property. There, your earnest money is typically applied to the down payment.
Your earnest money deposit is important, and you don’t want to risk losing it. Consider these precautions to protect your earnest money.
Always keep in mind the contingencies you and the seller put in place. Remember, contingencies are meant to financially protect both of you. Take the time to learn and understand what you are responsible for, and make sure you’re comfortable with the contingencies put in place that will allow a refund of the earnest money.
Buying your home is a big financial investment, so don’t settle for verbal agreements. Make sure any changes, big or small, are properly recorded in detail so everyone is held accountable for their responsibilities.
Delayed earnest money refunds are most commonly the result of missed deadlines. Whether it’s scheduling the home inspection or meeting the closing date, always keep top of mind what you are responsible for and when it needs to get done.
Buying a home may take a lot of patience, dedication and research, but few milestones in life can feel as rewarding. The effort you put into building your future should be matched with the effort American Family Insurance puts into protecting it. Take the next step in protecting your dream by exploring our homeowners insurance options or reach out to an American Family Insurance agent (Opens in a new tab) to get your quote today.
Have more questions about the home buying process? Be sure to check out our first-time home buyers guide to learn everything you’ll need to know from start to closing day.