Earnest Money: What Is It and How Much Should You Pay?

The earnest money deposit is a key part of the home-buying process. Earnest money comes into play when you’re ready to take the next step in purchasing a home. When you’re preparing to make an offer, your real estate agent will ask how much earnest money you’d like to put down. 

Earnest money, also known as a ‘good faith’ deposit, is a form of security deposit paid directly to the seller. It demonstrates your serious intent to buy the property and shows the seller that you are committed to the home purchase. In most cases, the earnest money deposit can also act as a deposit on the property you’re looking to buy. 

What is an earnest money deposit?

Well, what is earnest money? Earnest money is a deposit that shows the sellers your commitment to purchasing the home. Earnest money acts as a deposit for the home purchase and provides the sellers with compensation in case the deal is backed out without a contractual reason. After the seller’s agent verifies that your earnest money has been successfully placed into an escrow account, the buyer and seller will move forward by signing the purchase agreement. The seller’s agent will then update the listing to reflect a pending sale, essentially removing the property from active listings. From here, any necessary inspections, appraisals, and other conditions specified in the offer contract will take place as part of the final steps toward closing the deal.

Earnest money vs down payment?

Earnest money is different from a down payment. Earnest money is a good faith deposit showing commitment to the purchase. A down payment is an amount you’re paying upfront for a home and what a lender requires for qualifying financing. The usual amount for down payments is higher at 3% to 20% compared to earnest money. 

However, the earnest money you paid can be applied toward your closing costs or down payment depending on the agreement between all parties. Alternatively, you can receive your money back after closing. 

How much is earnest money?

The buyer and seller can negotiate the earnest money deposit amount, but it typically ranges from 1% to 3% of the sale price, depending on the market. However, if you’re buying a home in a seller’s market (when there are more buyers than homes for sale), or bidding on a highly competitive home, the earnest money deposit might range between 5% and 10% of a property’s sale price. 

Be sure to talk to your real estate agent about how much earnest money you should offer in the housing market you’re competing in. Offering a higher money deposit can make your offer stand out and show the seller you are serious about the purchase. They can help guide you on how to structure your offer to be most attractive to the seller while protecting your interests.

Do you need to pay earnest money?

Earnest money is not required, however, it has become common and beneficial. Since it is common, those who pay earnest money will make their offers appear more attractive in comparison to a weaker no earnest money offer. Although sellers have the option to waive the requirement for the deposit, this is not common. Earnest money is important in receiving the seller’s serious consideration.

How to pay earnest money? 

Earnest money is typically paid to an escrow account or title company, that holds it in an escrow account until the transaction closes. Other trusted third parties can include a real estate attorney. Payment methods include personal checks, cashiers, wire transfers, or money order spending on the terms of your contract. 

What if buyers don’t have earnest money?

Most sellers will not consider an offer without earnest money. Keep in mind, however, that it may be possible to negotiate a work-around. If you can’t afford an upfront money deposit, let the real estate agent and seller know right away. If your purchase method and financing look solid otherwise, maybe the seller will agree to move forward with the sale. If you are serious about the purchase, you may be able to ask a family member or friend to assist with a gift or loan of funds for the good faith deposit. 

A word of caution: Before taking a gift, institutional loan, or getting a cash advance on a credit card for your earnest money, be sure to consult with your mortgage lender. Any new gift, bank loan or cash advance that leads to high credit card balances during your transaction timeline could be detrimental to your mortgage loan approval. This deposit is meant to secure the property, not put it at risk of losing it.

Is earnest money refundable?

The money is refundable under certain conditions.

1. If the seller doesn’t fulfill their side of the purchase contract. For example, if the home inspection found faulty windows and the seller agreed to replace them – but did not follow through by the contract deadline. That breach of contract allows a buyer to back out of the purchase and receive a refund of their earnest money. 
2. If you have a contingency in place, and you have a reason related to that contingency to cancel the contract. There are a number of contingencies you can put into the contract and, if not met, you can walk away from the deal with your good faith deposit in hand.
3. The title company finds a lien against the property. 
4. Your lender denies you the loan, but you have a financing contingency in your offer.
5. If your offer is contingent on selling your current home, but you are unable to do so after a given period of time.
6. If you have an appraisal contingency, and the home appraises at a lower rate but the seller won’t reduce the price of the home.

Having a contingency may also allow you to negotiate the terms of your contract. For example, you may be able to ask the seller to perform repairs or give a credit at escrow to cover the agreed-upon repair costs. Typically, a buyer and seller can negotiate a resolution so the sale can be completed.

When do you lose earnest money?

Earnest money will be lost and kept by the sellers if you fail to meet the offer’s contractual obligations. These include: 

• You back out for any reason not listed as a contingency in the contract.
• After the due diligence period is over (usually a couple of weeks), you learn that the home sits in a flight path or near a refinery and you decide to walk.
• You cannot close on time, without a relevant contingency, and the contract has a “time is of the essence” term.

If you face any of these issues but still want to purchase the house, don’t give up. Have your agent get with the seller’s real estate agent. If you are upfront about the situation, the seller may extend the timeframe. 

In the case that buyers change their mind, there is a small chance for a refund. If the reasons are not included in the contingencies, the seller will keep the earnest money deposit. The earnest money is a “good faith” payment compensating them for their time and effort in helping you buy the home and sell it. 

How to protect your earnest money deposit

Take the following steps to protect your earnest money against fraud or unjustifiable forfeiture:

• Document everything. A home is one of the largest purchases many of us will make. Make sure the contract clearly defines what amounts to cancel the sale and who ends up with the money. Include any amendments to details like buyer responsibilities and timelines.
• Use an escrow account. Instead of working directly with the real estate seller or broker, use a reputable third-party, such as an escrow company, legal firm, or title company. Ensure the funds are securely held within an escrow account and obtain a receipt.
• Understand the contingencies. Familiarize yourself with the contingencies included in the contract, and double-check the contingencies that protect your interests are included. Do not sign a home purchase agreement that doesn’t have the clauses that protect you.
• Fulfill obligations. Real estate purchase agreements typically establish deadlines to safeguard sellers. Honor these deadlines and be sure to promptly address inquiries, submit necessary documents, and meet inspection, appraisal, and closing timelines.

Earnest money is an integral part of most real estate transactions. Before signing a Purchase and Sale Agreement to buy a home, carefully review all contingencies, understand how much money you’ll need to pay, and know-how to successfully recover your money if you need to back out of the sale.

Earnest money in action: Common scenarios

Let’s look at an example scenario of how earnest money may play out. Evan and Mia have listed their homes for sale in Washington, DC. Amelia is in the market for a new home and is interested in both properties and can’t make up her mind. In the event that both sellers require an earnest money deposit, three potential scenarios can unfold.

Scenario 1: The forfeited deposit

Because Amelia can’t decide which house to buy, she puts a good-faith deposit down on both properties, prompting Evan and Mia to take their homes off the market. 

Later, Amelia decides to buy Mia’s house. Now, Evan needs to relist their home for sale all over again. Luckily, Amelia’s earnest money is Evan’s to keep because Amelia backed out, which offers some compensation for time and money lost while the home was off-market.

Scenario 2: The early closing payment

After giving it some thought, Amelia decides to make a single deposit on Mia’s home and everything runs smoothly. On closing day, Amelia gets the keys and the deposit is put towards their down payment.

Scenario 3: The failed contingency

Amelia makes a single deposit to Mia. However, during the home inspection, Amelia discovers the electrical wiring is not up to code and will be very expensive to update. Luckily, Amelia has a home inspection contingency in the purchase agreement and decides not to buy and gets the deposit back from Mia.

Earnest money is an integral part of most real estate transactions. Before signing a Purchase and Sale Agreement to buy a home, carefully review all contingencies, understand how much money you’ll need to pay, and know-how to successfully recover your earnest money if you need to back out of the sale.

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