What is earnest money?
You pay earnest money when you buy a house, but how does it work and how much is enough?
Earnest money is a type of deposit the buyer puts down after their offer is accepted during the homebuying process.
Almost all buyers offer some amount of earnest money when they make a bid on a house. It shows the seller that you, the buyer, are serious about the transaction.
The funds are usually credited toward your closing costs or down payment when the sale goes through. However, there are a few scenarios where you could lose it, according to Jennifer Ashley (NMLS ID: 492958), a mortgage loan officer at ConsumerAffairs.
- Earnest money is due shortly after the seller accepts an offer.
- Earnest money is not the same as a down payment.
- Funds are credited toward your closing costs or down payment.
How does earnest money work?
When submitting a bid on a home, you and your real estate agent may choose to offer earnest money in the purchase agreement. Earnest money is a good-faith deposit you put down if your offer is accepted to demonstrate you are serious about buying the home. The purchase agreement specifies how much earnest money you are offering, when you will pay it, how you will pay it and the conditions for a refund.
Carefully draft the contingencies in your offer so you don’t lose your earnest money.
You write your earnest money check and give it to your Realtor. Depending on what state you live in, the check is held with the real estate brokerage or a title abstract company. Either way, it goes in an escrow account, according to Ashley, who has more than 20 years of lending experience at Bank of Oklahoma and elsewhere.
If the sale doesn’t go through because of a failed contingency, then you should be able to get your earnest money deposit back, Ashley said. The most common failed contingencies are when:
- An appraisal comes in lower than expected
- The home inspection reveals problems
- Financing falls through
If you (the buyer) are denied the loan for any reason, you should be able to get the deposit back, Ashley said. For instance, if your credit score drops, you lose a job, or your financial situation otherwise changes for the worse, your lender might not want to go through with the mortgage.
“The majority of the time, like if inspections go bad or something like that, it’s usually in the contract that they’ll get the earnest money back,” she said. “But really, if the borrower just walks away, that’s when he just doesn’t get it back.”
When it’s time to close on the house, a good mortgage company will verify who cashed the earnest money check (and for what amount). The deposit isn’t deducted from the sales price — it’s applied as a credit toward closing costs and down payments.
How much earnest money is enough?
How much you should pay depends mainly on market conditions. The earnest money amount is described as a percentage of the sale price or a specific dollar amount in your offer. Most often, you need at least between 1% and 3% of the property’s sale price.
The median sale price of a home in December 2021 was $358,000, according to the National Association of Realtors. The earnest money due on a $358,000 house would be at least $3,580 to $10,740, or 1% to 3%.
Market conditions can compel buyers to offer earnest money in amounts higher than 3% — sometimes up to 10% of the offer amount. If there’s a bidding war, “you know some people will be like, ‘Here’s $1,500 that you can have regardless — take my offer!’” Ashley said. In a highly competitive market where a home is attracting multiple offers, the seller might ask for a specific amount, or you might choose to offer more to make your offer more attractive.
Keep in mind that whoever is on the contract must provide the funds, Ashley said. Personal checks, cashier’s checks or wire transfers are the most common ways to transfer money into escrow. (You can’t pay cash — sometimes, people try to use “mattress money,” as Ashley calls it.)
Examples of earnest money
Let’s say you’re preapproved for a $100,000 FHA mortgage loan. (Average home prices are much higher in 2022, but let’s keep this example simple.) Because you have an FHA loan, the minimum down payment requirement is 3.5% ($3,500 on the $100,000 house).
You find a nice property in your price range, make an offer and the seller accepts. At this point, your earnest money will most likely be between $1,000 and $3,000 — let’s say it’s $2,000 (2% of the house’s sale price) for this example.
You have to pay the $2,000 deposit for the transaction to move forward as well as demonstrate that you can pay the full down payment amount, whether through a savings or checking account, gifted funds or a down payment assistance program.
You won’t see the $2,000 earnest money credited on your cost estimate because it hasn’t been officially verified yet. But, it will appear as a credit on the Closing Disclosure, which you review a few days before the closing date.
At closing, the $2,000 will be credited toward the $3,500 down payment requirement (or any additional closing costs).
The above example is generally what happens when things go smoothly. Below are real-life examples from ConsumerAffairs reviewers.
- Example: Credit score goes down
- Christopher, a Coldwell Banker Realtors reviewer in Texas, wanted to get out of a “bad renting situation” and had a “sizable down payment in cash.” They found a house that was “almost new. It had some minor problems, but was otherwise not a bad starter home.”
So, Christopher went to the brokerage office and put down an earnest money deposit.
“About three months into the process we find out that my credit is short of the 640 score requirement by eight points,” they said. “Then, we did not hear anything. Another month passed and we found out that we would not be able to close on the home. We lost our earnest money and Coldwell charged us $1,000.00 for processing the loan application.”
In total, they “lost $500 for an inspection, $1000 for the loan application, and $100 for earnest money. After gas and other expenses, we lost $2,000 and had nothing to show for it. At the time I was only making $8,000.00 a year at best. We decided to wait a few years and try again.”
- Example: Failed home inspection
- Donald, a RE/MAX reviewer in Illinois, said they agreed on a purchase price that was contingent upon a home inspection. They deposited their earnest money into an escrow account, with the understanding that they would get their money back if the contract didn’t go through.
“Several problems were discovered during the inspection,” they said. “Roof, AC and mold in the crawl space, plus several minor complaints by the licensed inspector. Estimates for repairs/replacement were obtained.”
However, the “seller refused to make repairs or replace the major items needed, or return the earnest money. Our agent kept repeating this has never happened before. You can go to small claims court, or get an attorney, but it would be equally expensive. Since we live in a different state, it was not practical.”
- Example: Permitting problems on a new-construction home
- Taylor, a Richmond American reviewer in Colorado, decided to build a new-construction home.
“After choosing a lot, paying earnest money, and making all of our selections with the design center, we got a call stating the permit on our house was ‘indefinitely on hold.’ … Turns out there was an issue with a plugged gas well, which is apparently common in Colorado,” the reviewer said.
They got all their earnest money back “about two weeks later.”
“I advise everyone considering working with new-construction builders to look up the street of your proposed new home for any issues that could hold up permitting or could cause issues down the line,” Taylor said.
- Example: Missing documents
- Jeff, a Guild Mortgage reviewer in Texas, got pre-qualified, submitted the necessary documentation and found “the perfect home.”
“I was told by the mortgage company all was good,” Jeff said. “Paid $600 for an appraisal, $600 for an inspection and put down $3,000 in earnest money. A closing day was set after they had me purchase homeowners insurance.”
But, just before closing, the lender asked for “over a dozen new items,” a couple of which were impossible to get.
“So not only did I lose the house, I am losing the $1,200 in appraisal and inspection fees as well as $3,000 in earnest money,” Jeff said.
- Example: Buyer changes their mind
- You can lose your earnest money deposit if you back out of the deal for no good reason. Imagine you put an offer on a house, the seller accepts, and you pay your earnest money.
But then, you find a house that you like a lot more. You change your mind about the whole transaction.
In this scenario, you’re backing out of the deal for a reason unrelated to contingencies, and the seller keeps your earnest money.
How to protect earnest money deposits
There are many ways to protect your earnest money when putting in an offer on a house. You need to ensure your money is going to the right place and that it will be refunded if one of your agreed-upon contingencies occurs.
- Work with reputable third parties: Do not give cash or a check directly to the seller. Your earnest money should be held in an escrow account or with the title company until you close on your house. Your real estate agent should explain how to keep your earnest money safe.
- Get everything in writing: The best way to protect your money is by writing contingencies into your purchase agreement. The most common contingencies are failed inspections (a leaky roof, mold or faulty wiring, for example) and appraisals coming in lower than the sales price. Always ask for receipts, and don’t authorize a release until the transaction closes.
- Adhere to the timeline: Once your offer is accepted, the clock starts ticking — it’s time to hold up your end of the agreement regarding closing. You have a set amount of time to perform an inspection, negotiate down any costs and lock in your loan. If you don’t meet your deadlines, you risk losing your earnest money.
Frequently asked questions
- Can you use down payment assistance toward earnest money?
- No, down payment assistance comes later in the mortgage process. Most likely, your earnest money would be due before you could receive any DPA funds, according to Ashley.
- Is earnest money the same as a good-faith deposit?
- Yes, the terms are often used interchangeably. A good-faith deposit for purchasing a home is the same as earnest money.
- Can you negotiate earnest money?
- You can sometimes negotiate a little bit, according to Ashley. However, negotiating too much could be a red flag — the whole point of earnest money is to prove that you will make good on the rest of the transaction. If you can’t afford the earnest money, you probably aren’t ready to buy a house.
- Do you need earnest money to refinance?
- No, you only need to make an earnest money deposit when you’re purchasing a home (whether it’s a primary, secondary or investment property).
- What is the difference between earnest money and a down payment?
- The down payment is the amount of money you put down upfront to purchase a home; the remainder of the home’s cost is covered by the loan. A down payment is due at closing. Earnest money is an amount that you put down after an accepted offer to show the seller you’re serious about purchasing the home. It’s put in escrow and eventually applied toward your closing costs and down payment.
- What is escrow?
- “Escrow describes a situation in which a neutral third party holds funds or an asset until a condition is met,” according to Bradley Schnitzer, a former accountant and business writer. For more, read about how an escrow account works.
- Will I get my earnest money back?
- Earnest money goes toward your down payment and closing costs, so check that it’s credited properly at closing. If the transaction fails, you can get the earnest money back as long as the reason relates to a contingency in the purchase contract. Examples of common contingencies include a home inspection that turns up serious problems, an appraisal coming in lower than the sale price or being unable to sell a current home before closing on the new one.
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