Understand the Role of Earnest Money in the Home Buying Process

Earnest money graphicAn earnest money for a house is what establishes your position as a serious buyer before other home buyers, and is a common part of the loan application process.

When you're ready to make an offer on a house, earnest money is often the best approach to demonstrate your seriousness. How to get your earnest money back, and what you need to know about contingency agreements, are all explained here.

What Is the Purpose of Earnest Money?

When you make an offer, it is customary for you to make an earnest money deposit. The deposit can be applied to your closing costs or returned to you at closing. A solid contract combined with an earnest money deposit demonstrates to a seller that you have the resources and desire to seal the deal. A significant deposit in your offer might even help it be chosen over others.

It is customary for real estate agents or title companies to hold your earnest money until the transaction closes. There are very strict rules regarding the earnest money deposit in each state. These funds stay in an escrow account until the closing.

Who stands to gain from earnest money?

The seller accepts a certain level of risk by pulling their house off the market, which is why earnest money is a very normal aspect of any real estate deal. If your home purchase agreement falls through for whatever reason, the seller has wasted time and may have lost out on other bids. The purpose of earnest money deposits is to mitigate that risk. It's also a good technique to prevent less serious purchasers from placing several bids and then withdrawing them after they've made their pick.

Earnest money serves as a type of insurance for the seller throughout the closing process. If you break the contract and decide to walk away from the transaction without a solid case, the seller may retain your earnest money deposit as compensation.

The earnest money deposit will be put toward your down payment and closing fees if everything goes according to plan and the house transaction goes off without a hitch. 

Is Earnest Money Refundable?

The purchase agreement will include contingencies that explain the conditions under which you may withdraw from the transaction without forfeiting your deposit. Included in the sales contract are hard and fast dates for any contingency. Failure to meet the contingency dates could jeopardize your earnest deposit.

Here are several frequent conditions that allow you to keep your deposit:

  • Mortgage contingency: If you cannot get financing, the mortgage contingency gives you an out.
  • Appraisal contingency: If the appraisal comes in at a lower value than the selling price, you will be unable to complete the sale.
  • Home inspection contingency: If the home inspection reveals defects and the seller is not willing to make corrections, you will be released from the sales contract.
  • Home sale contingency: The home sale contingency allows the home buyer(s) to back out of the sale if they are unable to sell their house.
  • Additional contingencies include pest, water purity and flow, and septic system.

Determine the contingencies you want to add in the contract with the assistance of your real estate agent.

In competitive markets, some buyers agree to nonrefundable earnest money, meaning the seller keeps the cash if the deal falls through for any reason. If you are tempted to employ this method, ensure you are aware of the hazards and do not provide money you cannot afford to lose.

Ensure that the contract includes contingencies to safeguard your interests. Most essential, you should not sign a home purchase agreement that lacks protection provisions.

Conditions for Earnest Money Refunds

Contrary to common misconception, homebuyers do not necessarily lose their earnest money to the seller in the event of a failed transaction. If the seller cancels the housing purchase without justification, the buyer receives a reimbursement of their good faith deposit.

You are also entitled to a refund if the cause for contract termination is a contingency specified in the purchase agreement. Examples of recognized deal-breakers in real estate include:

  • When a home inspection discovers serious issues with the structure of the house
  • In the event that the home's appraisal comes in at a lower value than the asking price of the property, and the seller is unwilling to renegotiate the sale price,
  • When the prospective home buyer is unable to get financing
  • When a buyer is unable to sell their existing house prior to the closing on their purchase of a new property.

It is important to understand the contract contingencies. If you are unclear about any aspect of the sales contract, speak to an attorney. 

When Is the Seller Permitted to Keep My Earnest Money?

The seller has the right to retain the earnest money if you breach the terms of the purchase agreement in any manner. Such as if you miss the dates specified in the contract, or if you decide not to purchase the house because you found a better one.

Before you sign any paperwork, your real estate agent should go over the full purchase contract with you and answer any questions you may have. Be sure that you are aware of your obligations under the deal, as well as the conditions under which you would be able to keep or lose the earnest money.

The provision of an earnest money deposit is not required, although sellers often expect receiving one to indicate the buyer's commitment to the purchase.

What Happens to the Earnest Money at Settlement?

Signing settlement documentsAt closing, the earnest money will be applied towards the down payment or closing costs. If there is any money left over, it will be refunded to the buyer. If the amount of the earnest money exceeds what's needed for closing costs or down payment, the excess amount will be refunded to the buyer.

How much money should I put down as a deposit to secure the house?

The amount of earnest money varies according to the area, seller, and price of the home you intend to purchase. The best way to learn about local customs is to chat with an experienced real estate agent.

Your earnest money deposit may range from 1-3% of the purchase price of an existing home and 10% of the buying price of a new home. It depends on the unique property, the competitiveness of the market, and other market-specific factors. On a $300,000 home, for example, a down payment of $3,000 might be necessary. For new construction, a homebuyer may be required to provide an earnest money deposit of up to 10 percent, or $30,000.

A competitive market may require a larger earnest money deposit. The majority of real estate professionals concur that purchasers should include an earnest money deposit that will be treated seriously, but not so much that the buyer's finances would be jeopardized. Although it is rare that you would lose your earnest money investment, it is necessary to protect yourself.

When deciding how much money to put down, the following should be taken into consideration:

  • The condition of the housing market both locally and nationally.
  • How soon you are able to complete the transaction.
  • What kind of urgency does the seller have?
  • When making an offer on a house when there is no other competition, you should put down a deposit equal to around one percent of the asking price.
  • If you are making an offer on a property, and you are aware that other individuals are looking at the home, you should think about putting down somewhere between 1 and 5 percent.
  • It is possible that a one-time cost ranging from $500 to $2,000 is appropriate, although this depends on the residence.

If the contract is broken, the terms of the contract say where the earnest money goes. Most contracts have clauses that let buyers back out of a deal if something unexpected happens.

Rotating question markFAQs About Earnest Money Deposit

Q. Is earnest money negotiable?

A. The deposit made by the buyer at the time of the sale can be negotiable, and is usually a percentage of the purchase price.

Q. Is earnest money part of down payment?

A. Yes, earnest money is part of the down payment. It's a deposit you make to show that you're serious about buying the property. The earnest money can also be applied to the closing costs.

Q. Is earnest money required?

A. Technically, there is no requirement for an earnest money deposit.

Nonetheless, sellers typically anticipate an earnest money deposit alongside an offer.

Q. Is earnest money tax-deductible?

A. Except for prepaid interest, prepaid property tax, and loan origination fees, your new-home closing costs are not tax-deductible. Deductions for appraisal, inspection, settlement, etc., are not allowed.

Your earnest money deposit is not tax-deductible. Your homeowner's insurance premiums for fire, hazard, flood, etc. are not deductible on your primary residence. Improvements, repairs, and upkeep performed on your residence are not tax-deductible.

Q. Is earnest money the same as escrow?

A. No, earnest money is not the same as escrow. Earnest money is a deposit made by a potential homebuyer to show that they are serious about buying the property. Escrow is a third party that holds funds and documents related to a transaction until its completion.

Q. Who is earnest money paid to?

A. Escrow accounts or trusts managed by third parties, such as law firms, real estate agents, or title companies, are common vehicles for deposit of earnest money. Personal checks, cashier's checks, and wire transfers, among others, are acceptable forms of payment.

The earnest money deposit should be made out to a trustworthy third party, such as a respected real estate agency, escrow company, title company, or law firm (never give the deposit directly to the seller).

Read more questions and answers about conventional loans


In conclusion, earnest money is an important part of the mortgage process. It shows that you are serious about buying the home and allows the seller to feel confident in the sale. It is important to understand the importance of earnest money and how it can help you during the mortgage process.

Earnest Money Deposit
How is an Earnest Money Deposit Verified?

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