What Is Earnest Money and How Much Do I Need?
If you're a first-time homebuyer, or it's been a while since your last home-purchasing experience, you may be unfamiliar with earnest money. In brief, it's a small deposit that proves to a seller that you're serious about wanting their home.
But when and how much you need is complicated.
Here’s how to navigate earnest money like a pro.
What Is Earnest Money?
Earnest money is a deposit you put on a property you plan to purchase. You will often see it referred to as an earnest money deposit.
Some other common names for earnest money include:
Good faith money/deposit
Why Do You Need an Earnest Money Deposit?
Your earnest money deposit shows the seller that you're serious about purchasing their property. It’s also motivation for the buyer: the seller can keep your earnest money if you back out of the sale for a reason not defined ahead of time in the purchase contract.
Earnest money shows the seller you have a strong incentive to go through with the transaction.
This is important to sellers because accepting a purchase agreement generally means taking their home off the market. If something were to happen with the deal, the seller would need to relist their property and restart the search for a buyer. This could mean weeks or even months wasted in some cases.
How Much Earnest Money Do I Need?
One of the most common questions regarding good faith deposits is, "How much earnest money do I need?" Unfortunately, there isn't one single answer to that question.
Standard earnest money deposits can vary significantly from area to area. They also tend to change over time based on market conditions. You can probably get by with a smaller escrow deposit in a buyer's market than when conditions favor sellers.
As an estimate, earnest money is usually expected to be between 1% and 3% of the purchase price. However, you could find EMDs as high as 10% in some competitive markets in recent years.
How Do I Pay Earnest Money?
You will usually pay earnest money when your purchase offer is signed (agreed to) by the seller.
This means you should have your earnest money deposit sitting in your checking account as you make offers. You may need to transfer it quickly.
Funds don’t get paid directly to them, though. The money will be put into an escrow account until closing or the termination of the contract.
For real estate purchases, you’ll generally use an escrow account held by a:
Real estate brokerage
Real estate law firm/escrow attorney
Earnest money can be deposited into the escrow account by personal check, certified check, or bank transfer. Payments are typically made out to the firm holding the escrow account. If you’re working with a real estate agent, they will guide you through the specifics for your transaction.
Is an Earnest Money Deposit Refundable?
Although an earnest money deposit is meant to protect the seller, the money is refundable in some situations. These scenarios will be outlined in your real estate contract, called contingencies.
Although contingencies can sometimes benefit sellers, they typically allow the buyer to terminate the purchase contract without ramifications and receive their earnest money deposit back.
The four most frequently used real estate contingency clauses are:
It's possible to be denied a mortgage after signing a purchase agreement, even if you've already been pre-approved.
Common reasons this can happen include:
Significant purchases/increased debt
Negative activity on your credit report
If you have a financing contingency in your contract, you'll be able to back out of the purchase and receive a refund of your earnest money in the event that you cannot secure a mortgage. You may also see it referred to as a mortgage or loan contingency.
Having an appraisal contingency gives you the option to terminate your purchase agreement if the home doesn't appraise for at least the purchase price. If the home under-appraises, you can cancel and get your EMD back. Often, buyers use an under-appraisal to negotiate a lower purchase point with the seller.
Home Inspection Contingency
Sometimes, homes can have severe defects that aren’t noticeable to the untrained eye.
Purchase agreements with a home inspection contingency allow you time to get a licensed home inspector to check out the property. If you’re unhappy with the home’s condition, you can back out and get your good faith deposit returned.
You will often see the home inspection contingency referred to as a due diligence period.
Home Sale Contingency
A home sale contingency is used when you need to sell an existing property before closing on the purchase. If you're unable to sell your current property, for example, if your buyer backs out, you can terminate your purchase agreement and get a refund of earnest money with a home sale contingency.
Is My Earnest Money Credited Toward My Down Payment?
Yes! If you’ve upheld the terms of the contract and are going through with the purchase, 100% of your earnest money will be applied toward the down payment and closing costs. You may even get a check at closing if your loan requires no down payment and closing costs were covered by other sources.
Say your total down payment and closing costs are $19,000, and you've already made an earnest money deposit of $5,000. In this scenario, you would only need to bring $14,000 to the table, as the $5,000 EMD will be credited on your closing statement.
Purchase Offers Need More Than Just Earnest Money
Earnest money is an integral part of nearly any real estate transaction. Without a good faith deposit, you're unlikely to get your purchase offer accepted by a seller.
If you're planning to finance your new home, you will also need a lending pre-approval letter. As with an EMD, lender pre-approval shows you are serious about buying a home. If you want to make offers that get accepted, contact a lending professional to get started with the pre-approval process.
Tim Lucas spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. Tim has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, My Mortgage Insider, and more.