Takeaways
- Earnest money is a good-faith deposit made on behalf of prospective homebuyers.
- Earnest money deposits range from 1% to 3% of the asking price but vary by market.
- Earnest money deposits are usually held in an independent escrow account.
- Earnest money deposits align the buyer and seller toward completing the transaction.
- Homebuyers could lose their escrow payment if they violate the purchase agreement.
What Is Earnest Money?
An earnest money deposit is a good-faith deposit made to a home seller to let them know you are serious about buying their house. Earnest money is usually a percentage of the total asking price of the home. Depending on how competitive your real estate market is, this amount varies between 1% to 3% of the asking price. Earnest money is put into an escrow account, demonstrating you are serious about buying their home.
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The whole point of earnest money is to protect the seller from buyers who aren’t serious about making an offer. Requiring earnest money can help you if you are trying to sell your house because it forces the potential buyer to have a stake in the game. Additionally, it narrows homebuyer’s attention to one house because once they pay earnest money into escrow, this indicates a significant interest in the property.
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How Earnest Money Works
Depending on the competitiveness of the homebuying market, listing agents will list houses on websites like Zillow and Realtor to generate buzz about a property. Once a homebuyer has found interested buyers (sometimes through a buyer’s agent) there is a negotiation, and an offer is made to purchase the house. Once this happens, the house is removed from the market.
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An earnest money deposit (EMD) is made into an escrow account to signal to the buyers that you are serious about purchasing their house. Funding the earnest money kicks off the purchase agreement phase, and the house is considered under contract. If you buy a home for which you paid an earnest deposit, this deposit can be applied toward the closing costs or down payment for your house.
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How Do You Lose Earnest Money?
Technically, an earnest money deposit is at risk of being forfeited to the seller. The exact reasons why you might lose your earnest money are defined in the purchasing agreement. The whole point of having an earnest deposit is to make a good-faith gesture that you are serious about purchasing a house.
Here are several ways that you might lose your deposit:
- Failed Home Inspection: What happens if the home inspector finds an unresolvable issue with the home? Planning for this is known as home inspection contingency. This contingency can allow you to get out of the transaction.
- Unable to Get a Mortgage: At the end of the day, you must be able to fund the purchase price of the home you want. Many home shoppers enter the market with a pre-approval letter from a mortgage lender or bank. But if you don’t officially get approved for a mortgage, you could have a contingency for this called a financing contingency, which could let you get out of the transaction.
- Low Appraisal: In competitive markets, homes can get overvalued quickly. That is where a home appraisal comes in. If the home appraisal is lower than the selling price, you might have to pay the difference in cash. If this happens, you can get out of the transaction and get your earnest money back.
- Can’t Sell Your Home: If you aren’t a first-time homebuyer, you might need to sell your current house before purchasing a new house. Many purchase agreements allow for a contingency when selling your existing home. If this doesn’t happen, you might be able to get your earnest deposit back.
- Non-Refundable Earnest: In hypercompetitive markets, you can sign up for a non-refundable earnest deposit, which you will not get back if you later decide not to buy the house. This can be a risky proposition, but it might also help secure the home you want.
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Can a Home Seller Keep My Earnest Money?
Whether or not the home seller gets to keep your earnest money deposit depends on the purchase agreement. A seller doesn’t want to delist their home from the market and have it “under contract,” only to have it resurface back to the market because you changed your mind. This could cost the home seller money and time.
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Your real estate agent should walk you through the proposed purchase agreement so that you know what you are signing up for and what actions might cause you to lose your money. It is a smart money move to talk about this with your buyer’s agent before you even begin the home shopping process.
Smart Summary
The home-buying process is full of transaction-specific events, and paying earnest money in a competitive real estate market is one of those steps. If you have found your perfect home, consult a real estate agent to help you talk through the pros and cons. Alternatively, you can hire a buyer’s agent to guide you through the process. Being prepared to pay an earnest deposit is essential to acquiring the house you truly want.
Frequently Asked Questions
Earnest money and down payments are two separate steps in the home-buying process. An earnest money deposit is a good faith deposit made to demonstrate you are a motivated buyer. However, a down payment is the cash paid to the lender to purchase a home. Mortgage lenders and banks will issue a mortgage for the remaining difference between your down payment and the selling price.
Technically, you are not required to pay earnest money. However, motivated sellers and listing agents won’t want to deal with a prospective buyer who does not want to enter into a purchasing agreement without an earnest payment.
You should consult your real estate agent on the latest market expectations for earnest money payments. In hot real estate markets, it may be as much as 3% of the selling price, while in a buyer’s market, it could be as little as 1% (if anything).
