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What is earnest money when buying a house?

Yahoo Personal Finance· Getty Images
Updated 5 min read

Earnest money — yet another unfamiliar term that's popped up when buying a home. Put it up there with escrow, amortization, DTI, PMI, and all the other letters, words, and phrases that are a part of the mortgage loan process.

This one is pretty easy, though. Trust us.

In this article:

Dig deeper: How to get a mortgage — from prepping finances to closing

What is earnest money? In real estate, it is a good-faith deposit, plain and simple. You agree to buy a house from a seller and sign a purchase agreement. At that point, the seller will ask for an earnest money deposit through their real estate agent.

You'll give the agreed-upon amount (payable to a third party) to the agent, real estate attorney, or title company. The third party will hold the funds in an escrow account. Don't give the earnest money directly to the seller. If a dispute arises, you may have great difficulty getting your money back, even if you deserve it.

While earnest deposits are not generally a legal requirement, many sellers expect it — especially in competitive markets. If a buyer doesn't offer a good faith deposit, a seller may seek another buyer.

When you go to sign all the loan paperwork, that earnest money comes back into play.

Since everyone has held up their end of the bargain — you're all set to buy the house, your loan is approved, and the seller is good to go — the good faith earnest money that's been on the sidelines for the past couple of weeks will be returned to you. It will likely be applied to your closing costs or the down payment.

Learn more: What to expect when closing on a house

Yes, you can get the earnest money back under certain conditions. Some common contingencies include:

  • A home inspection contingency. For example, if a major problem with the house is revealed in a home inspection that requires extensive repair, the buyer may be able to back out of the deal and get their earnest money refunded.

  • A financing contingency. You may also get your earnest money returned if you cannot obtain financing from a mortgage lender for the home purchase.

  • A home sale contingency. If you fail to sell your home, which precludes you from buying the house under a purchase contract, you may get your good faith deposit back.

  • Appraisal contingency. If the home fails to appraise for the agreed purchase value, you may also get your earnest money deposit refunded. Or, you may have your Realtor renegotiate the sales price with the seller.

You'll want to discuss with your real estate agent all of the scenarios for getting your earnest money back, as well as the contingencies you may want to include in the sales contract. Remember, if any condition is not written in the contract, in effect, it doesn't exist.

You can see that these contingencies can protect your interests and get your earnest deposit money back if things don't work out. However, in the recent tight housing market, many buyers have decided to forego some — or all — contingencies. It's an effort to reduce friction in a real estate transaction and be seen as a "get along" buyer.

It's all a factor as to how competitive your real estate market is.

Waiving all contingencies is generally not recommended unless you're in an overheated market. And even then, the risks include losing your earnest money deposit with nothing to show for it but bitter disappointment.

Read more: How to make an offer on a house

While you’ll usually get your earnest money back, that deposit can go to the seller under certain circumstances too. For example:

  • If you simply back out of the deal after signing a purchase agreement. That includes when you find a better house or decide you don't like the home under contract anymore — you'll almost certainly lose the earnest money.

  • If you violate any terms of the purchase agreement, such as missing a deadline for your financing or closing.

  • If you offered a nonrefundable earnest money deposit to make your purchase offer more attractive to the seller in a competitive market. If the deal falls through, you'll probably lose your earnest deposit.

It's important to remember: Until the minute you close on the house, your earnest deposit is at risk.

Read more: How long does it take to buy a house?

Earnest money deposits can range from 1% to 5% of the purchase price. It could be much more or even less. For new construction, builders may require as much as 10%. Either way, it's not a small number. The amount also depends on how active your local real estate market is, how motivated the seller is to make a deal, and how a negotiation pans out.

Your Realtor can guide you to the proper amount to offer in your real estate market.

Yes. That's the short answer, but it all depends on how motivated everyone sitting around the bargaining table is. How badly do you want the home? How much does the seller want to make a deal? Is your real estate market a buyer's or seller's market?

If all goes well at the closing table, yes, you can apply the earnest money to the down payment and closing costs. In the best-case scenario, it is simply part of your down payment paid up-front. However, it is very much at risk. In a real estate transaction, the earnest money is truly a security deposit to assure the seller that you are a serious buyer and have every intention of moving to loan closing.

It is. Earnest money, good-faith deposit, security deposit, contract deposit, escrow deposit — they all are essentially the same thing.

This article was edited by Laura Grace Tarpley.