What Exactly Is Earnest Money?
For first-time homebuyers, real estate jargon can be intimidating. Terms like FSBO, acceleration clause, and stick-built might seem like a foreign language, but at least in the case of earnest money, the definition is simple. Earnest money is a deposit that proves buyers are serious about completing the purchase of a home (apartment or other dwelling). In fact, earnest money is sometimes called a "good faith deposit," referring to the fact that the buyer is expected to act in good faith during the purchase process.
Per real estate experts, a typical earnest money deposit is 1% to 3% of a home's purchase price, though 10% isn't unheard of in particularly competitive markets or for a desirable home listing with multiple offers. The amount of earnest money being offered is usually specified on the purchase agreement or sales contract that the buyer's agent draws up when making an offer to purchase a property on behalf of their client.
If the seller accepts the offer, the prospective buyer is required to submit the agreed-upon earnest money to a third party like a title company or law office, usually within one or two business days of contract acceptance. Alternatively, if a buyer wants to demonstrate they're particularly serious about buying a home, a check for the good faith deposit may already accompany the offer paperwork, rather than wait for the offer acceptance to proffer the money.
Is earnest money refundable?
With a $412,000 median home price in the U.S. in late 2023, earnest money deposits today will amount to at least a few thousand dollars and can quickly escalate into five figures. Since that's not exactly an insignificant amount of money, what happens if you don't complete the transaction? Is earnest money refundable? Like many things in life, it depends.
The exact conditions that dictate whether or not earnest money is refundable are spelled out in the terms of the offer or purchase contract. However, there are a few criteria, called contingencies, that typically allow a refund of the escrow money if they're not met. One such qualifying contingency is if a home inspection reveals any significant defects in the construction or condition of the property. Another common contingency is when the property appraises for a value less than the selling price. Similarly, buyers sometimes include contingencies specifying the return of earnest money if they can't qualify for a mortgage, or need to sell their existing home before proceeding with the new purchase.
In some cases, homebuyers might voluntarily put their earnest money at risk by waiving some of these typical contingencies. For example, a buyer with strong finances and excellent credit might opt to waive a financing contingency, knowing it's unlikely they'll have a problem securing a mortgage. Removing contingencies can make a buyer's offer more attractive and stand out among competing offers.
The money is usually applied toward the down payment
Of course, if a buyer flat out changes their mind or ignores the timelines of the transaction — like waiting until after the contingency period expires to apply for a mortgage, then getting rejected — there's a good chance the good faith deposit will be forfeited. Those escrow funds will effectively compensate the seller for the time, trouble, and lost opportunity of removing the property from the market, then having to relist it. On the other hand, assuming the purchase process goes well and it's time to close on the property, then the buyer can opt to have the escrow money refunded. However, what's more common is for the escrow funds to be applied toward the buyer's down payment or closing costs.
In summary, although earnest money isn't strictly required when making an offer to purchase real estate, doing so will make for a stronger proposition in the eyes of the seller. Speak with a licensed real estate agent about what contingencies make sense for your personal situation and make sure to include all the details in writing as part of the contract. Once an offer is accepted, make sure to give the good faith deposit to a reputable third-party source where it will be held in escrow. Never give money directly to the seller or to their agent. Finally, make sure to stay abreast of the contingency timelines defined in the contract and complete tasks, like applying for a mortgage or scheduling a home inspection, while the earnest money deposit is still refundable.