What is Earnest Money and How Does it Work?

When you buy a home, there are several upfront costs to consider beyond your monthly mortgage payment. Typically, the largest of these costs is your down payment, but there are other costs you should be prepared for as well.

One of these upfront costs is an earnest money deposit, also known as good-faith money. Learn more about how it works and how much you should expect to pay.

What is an earnest money deposit?

When you are ready to make an offer on a home, there are several ways you can make yours stand out from any others: from the offer price and preapproval to the closing date and contingencies. Another option you may consider is putting down an earnest money deposit.

Earnest money is a sum of money you submit with your offer before closing to show the seller you are serious about purchasing the home. It is important to note that earnest money is not required during the sales process, rather it may add additional incentive for the seller to select your offer. Typically, earnest money totals 1% to 5% of the purchase price.

How does it work?

When a seller accepts your offer to buy a home, the home is taken off the market while you enter the closing period. During this time, which typically lasts 30-45 days, you will negotiate and finalize the contract, and eventually close on the loan. While this is happening, your earnest money will be placed into an escrow account and held by a designated third-party until it is time to be paid out, usually in one of two scenarios:

• You and the seller finalize a contract. At closing, you can apply the deposit toward your down payment or closing costs.
• You back out of the deal. If you back out of the deal after the seller accepts, you may forfeit this deposit to the seller. In this way, the earnest money deposit works as a kind of insurance for the seller.

Is my earnest money deposit refundable?

Earnest money deposits do come with contingencies that protect both buyers and sellers. These contingencies are a normal part of the homebuying process and provide legal protections if certain conditions are not met.

There are several common types of contingencies, all of which can be found in your home purchase contract:

• Home inspection contingency.
• Appraisal contingency.
• Mortgage contingency.
• Home sale contingency.

During the closing period, if your contingencies are not met, you can still walk away from the sale without losing your earnest money. Be sure to speak with your real estate agent about which contingencies to include and how to make a strong offer.

Keep in mind that some states may require additional deposits along with your earnest money. Work with your real estate agent to better understand the specific requirements in your state.