Earnest Money - Definition & Advantages of Earnest Money | What is Earnest Money? (2024)

FAQs

Earnest Money - Definition & Advantages of Earnest Money | What is Earnest Money? ›

What Is Earnest Money? In real estate, earnest money is effectively a deposit to buy a home. Usually, it ranges between 1-10% of the home's sale price. While earnest money doesn't obligate a buyer to purchase a home, it does require the seller to take the property off of the market during the appraisal process.

When you find a home and enter into a purchase contract, the seller may withdraw the house from the market. Earnest money, or good faith deposit, is a sum of money you put down to demonstrate your seriousness about buying a home. In most cases, earnest money acts as a deposit on the property you're looking to buy.

Earnest money is put down before closing on a house to show you're serious about purchasing. It's also known as a good faith deposit. When a buyer and seller enter into a purchase agreement, the seller takes the home off the market while the transaction moves through the entire process to closing.

Earnest money has become standard, especially in today's competitive real estate markets. The purpose of earnest money is to tell the seller that you're serious about purchasing the home. By backing up your offer with some cash, a seller is more likely to trust that you'll follow through with the home purchase.

Earnest money is typically held by a third party in an escrow account. The money remains in the account while both parties complete the terms of the contract. At closing, the funds are returned to the buyer and are often applied to the down payment or closing costs.

You can expect your earnest money back if: The home doesn't pass inspection. The home appraises below its sale price. You are unable to obtain a mortgage.

The earnest money deposit serves as the liquidated damages amount in real estate contracts. If the buyer defaults, the seller can keep the deposit regardless of the actual amount of damages. That also means that if the damages are higher than the liquidated damages – you're out of luck!

Sometimes a relative or close friend offers to give you money to help buy your home. If the earnest money comes from a gift, you'll need a signed gift letter to show proof of the escrow deposit. The letter will need to include the amount of the gift, the relationship of the donor, and that they do not expect repayment.

Earnest money is usually a percentage of the base home price, while a down payment is a percentage of the total home price after all additional costs, such as personalization selections, are calculated. Earnest money is collected when the contract is signed and the down payment is paid at the time of closing.

If you lost earnest money due to a failed personal home purchase, you cannot claim the loss on your return. If you lost earnest money due to a failed business purchase of a rental home, you may claim the loss. The loss would be considered a capital loss you would write off on your Schedule D.

Should I walk away from earnest money? ›

You Could Lose Your Earnest Money Deposit

You could lose it if you walk away from a sale for a reason not covered by contingencies in the contract. If you walk away from a home purchase due to a reason covered by the contingencies in the contract, you can get your earnest money back.

This could include an appraisal price that is lower than the sale price, or if there is a significant flaw with the house. Importantly, though, earnest money may not be returned if the flaw was not predetermined in the contract or if the buyer decides not to purchase the house during an agreed-upon time period.

When the buyer signs the offer to purchase, the buyer usually deposits a sum of money with the seller, the seller's real estate agent, or the seller's attorney. Your offer should specify that the earnest money deposit will be placed in an interest bearing account with the interest credited to the buyer.

Even if the seller doesn't pursue legal action should you not pay earnest money following an agreement to do so, they'll almost certainly terminate the purchase contract. This will, of course, mean you lose the right to purchase the property, allowing other interested parties to come forward and stake their claim.

The amount of earnest money you'll need to pay is typically 1 percent of the home's purchase price, but it can depend on the type of transaction and the nature of the broader market. On a $355,000 home, for example, you'd put down $3,550 as an earnest money deposit.

While a contract, to be valid, must have consideration, earnest money is not the only consideration included. Earnest money is a good faith deposit and may not be necessary to have a valid contract.

In most cases, earnest money is refundable to the buyer if the sale does not go through for reasons that are not the fault of the buyer. Some common situations where earnest money is returned include: The home does not appraise for the purchase price.

Here's the difference between earnest money and down payment. The main thing to remember here is that the earnest money deposit is for the seller, and the down payment is for the lender. Earnest money is typically 1% to 2% of the total purchase price, as opposed to the 3.5% to 20% for your down payment.

Earnest money, also known as earnest money deposit (EMD) or simply earnest deposit, is a payment made by a buyer to a seller as a demonstration of the buyer's sincere intention to purchase a property or enter into a business transaction. It is a way for the buyer to show commitment and seriousness about the deal.

While earnest money is not necessarily required, most sellers won't go under contract without it. The amount of earnest money varies and is negotiable, but usually falls between 1% and 2% of the purchase price.