How To Define Earnest Money: Home Buying 101

Earnest money deposit or EMD is the money you will deposit at an escrow company once your offer on a house is accepted. The amount will usually be deducted from your down payment or used toward closing costs.

While it does not guarantee that your offer will be accepted, it does show that you're sincere in your intention to buy. Suppose you decide not to move forward after the seller accepts your offer. In that case, you risk losing the deposit to the home seller if the deal falls through because of an unforeseen event.

An experienced real estate agent may refer to EMD as having 'skin in the game' or good faith money.  When you offer a low amount of earnest money deposit upfront, it shows that you are not invested in making sure the purchase is successful. If the deal falls through, there is no substantial financial impact on you.

In real estate, earnest money is a deposit made by a buyer as proof of good faith they plan to complete the purchase. If your EMD is high,your offer will stand out from other buyers, showing the seller that you're serious about moving forward with their property.

The contingencies within the purchase contract are legitimate reasons why the buyer can elect to withdraw from the purchase and request the earnest money be refunded.

The buyer usually covers up-front expenses such as home inspections or appraisals. Earnest money can serve as  assurance that the buyer will follow   through with the terms stated in the sales contract. The good faith deposit also avoids costly legal disputes involving buyers who renege after making an offer before closing on a home purchase.

What Is Earnest Money Used For?

Once both parties sign the purchase agreement, the earnest money is deposited into an escrow account and they enter into a binding contract. 

The EMD protects the buyer by preventing the seller from entertaining or accepting other offers while performing their due diligence. Allowing them time to perform their home inspection, conduct an appraisal, and review the homeowners association documents. 

Buyers having to put down earnest money prevents them from nonchalantly throwing around lowball offers or submitting offers on multiple properties. The earnest money deposit makes sure neither party backs out of the deal without a reasonable cause.

Earnest Money: How Much Earnest Money Is Enough?

In most states, the typical earnest money deposit is about 1% to 3% of the home's purchase price. In some local real estate markets, it can be common for buyers to pay up to 10%.

Example based on Home Price:

Depending on your financial situation, the house, and the local real estate market, the amount you pay will vary. Make sure your offer states the terms under which earnest money will be returned if the sale falls out due to the buyer or seller backing out of the deal.

You need to deposit the EMD within a few business days of both parties having signed the purchase agreement. Before entering into a binding agreement you should have the check prepared or know which account you intend to wire the funds from.

Remember, when you are in love with a particular home, and there are multiple offers, putting down more earnest money shows you're serious about buying. Paying earnest money directly to the seller you are better prepared financially to follow through on your promise of purchasing their home.

You pay the earnest deposit to a reputable third party, such as a title company or legal firm. They hold the funds in an escrow account until the purchase is either completed or terminated. You can typically pay earnest money by personal check, certified check, or bank wire transfer.

Check with your real estate broker to confirm the rules for your state when it comes to depositing the EMD. If you do not deposit within the agreed amount of time outlined in the purchase contract, you will be in breach. The seller could then choose to move forward with another buyer’s offer.

In most real estate contracts, earnest money is a requirement. A section called consideration outlines the monetary requirements for the real estate purchase agreement to be considered legally binding. Your offer will not be taken as serious without an earnest money deposit because you could withdraw from the purchase with any repercussions. .

A real estate brokerage will use the EMD as confirmation the purchase is moving forward  because most local Multiple Listing Services (MLS) typically require them to change the status to 'under contract' when an offer to buy is accepted. Although it is unlikely that the seller will accept your offer with no EMD, they can choose to waive it if conditions aren't favorable in a slow market.

In the purchase agreement, there are a set of contingencies to protect your earnest money.

Example of Contingencies:

These are all buyer responsibilities, so it is crucial to understand contract contingencies when purchasing  a home. Make sure to discuss the purchase agreement with your Realtor or an attorney before signing on the dotted line.

If the seller terminates the sale without a compelling or agreed-upon reason, the buyer regains the good faith payment.

A seller can elect to keep the earnest money deposit if the buyer breaches an important provision in their contract.

An example is if the buyer fails to conduct a home inspection within the agreed-upon timeframe but refuses to move forward unless they can get an extension. Suppose the seller had given the buyer easy access to conduct an inspection; in that case, the seller is not obligated to provide the buyer with an extension.

A sale of a home is often an emotionally draining process. The earnest deposit gives the seller peace of mind that they won't be placed in financial distress if the sale does not move forward. Remember, the seller has to pack, prepare movers, and clean the house by the agreed-upon closing date.

Sellers may keep the earnest money deposit if the buyer agrees to purchase a home but changes their mind during the home buying process for reasons that were not listed as contingent. It compensates the seller for the time and money needed to re-market their property. 

As part of the purchase contract, if the seller agreed to return the EMD if the appraisal value came in low, then they must honor that contingency.

The purchase agreement and earnest money are a formalized recognition of your intent to purchase. Earnest money highlights the buyer’s motivation and is due at the beginning of the transaction. The downpayment   is connected to the type of financing the buyer is receiving and typically tied to the loan amount. The down payment is  paid a few days before the closing.