What is Earnest Money when Buying a Home? Understanding the Basics

When you’re buying a home, you may have heard the term “earnest money.” It’s an important part of the home buying process, but what exactly is it? In this article, we will delve into the basics of earnest money, including its purpose, amount, and how it can impact your home buying journey.

What is Earnest Money?

Earnest money is a deposit made by the buyer to the seller or the seller’s agent when making an offer to purchase a home. It serves as a sign of good faith that the buyer is serious about purchasing the property. The earnest money deposit is typically held in an escrow account until the closing of the transaction.

Why is it Required?

Earnest money is required to protect the seller in case the buyer backs out of the deal. When a buyer makes an offer on a property, the seller takes the property off the market and stops looking for other potential buyers. If the buyer decides not to follow through with the purchase, the seller could potentially lose other potential buyers and time on the market.

Earnest money also serves as a financial commitment by the buyer. By making a deposit, the buyer shows they are serious about the purchase and are willing to put money towards the property.

How Much Earnest Money is Required?

The amount of earnest money required can vary depending on the seller and the market. Generally, earnest money is around 1-2% of the purchase price of the home. In competitive markets, the amount may be higher, while in slower markets, it may be lower.

Here is a link to existing home sales in the US per region: https://www.nar.realtor/research-and-statistics/housing-statistics/existing-home-sales

Who Holds the Funds?

The earnest money is typically held by a neutral third party, such as a title company or an attorney. The third party is responsible for holding the funds in an escrow account until the closing of the transaction.

What Happens to the Money?

If the transaction is completed, the earnest money is applied towards the down payment or closing costs. If the deal falls through due to contingencies or other reasons, the earnest money may be returned to the buyer or kept by the seller.

Can I Get It Back?

The buyer can get their earnest money back if the sale falls through due to contingencies or other reasons. Contingencies can include financing, appraisal, or inspection contingencies. However, if the buyer backs out of the deal for reasons not covered by the contingencies, they may forfeit their earnest money.

When Do I Need to Pay Earnest Money?

The deposit is typically paid when making an offer on the property. It shows the seller that the buyer is serious about the purchase and is willing to put money towards the property.

How to Pay Earnest Money?

The earnest money is typically paid in the form of a check or wire transfer. The payment is made to the neutral third party holding the funds in an escrow account.

How to Protect Your Earnest Money?

To protect your earnest money, it’s important to include contingencies in the purchase agreement.

Earnest Money vs. Down Payment

While earnest money is a deposit made when making an offer, the down payment is a larger payment made at the closing of the transaction. The down payment is typically a percentage of the purchase price, while earnest money is typically a smaller percentage of the purchase price.

Earnest Money vs. Option Fee

An option fee is another type of deposit made by a buyer when making an offer on a property. An option fee gives the buyer the option to terminate the contract within a specified timeframe, usually a few days. If the buyer decides to terminate the contract, they forfeit the option fee, but they get their earnest money back.

Earnest Money and Contingencies

Contingencies are conditions that must be met before the sale can be completed. These conditions can include financing, appraisal, or inspection contingencies. If the contingencies are not met, the sale may fall through, and the earnest money may be returned to the buyer.

Conclusion

Earnest money is an important part of the home buying process. It serves as a sign of good faith by the buyer and a financial commitment towards the purchase. It also protects the seller in case the buyer backs out of the deal. Understanding the basics of earnest money can help you navigate the home buying journey with confidence.

FAQs

Is earnest money required when buying a home?

While it’s not required, earnest money is typically expected when making an offer on a property.

Can the seller keep the earnest money?

If the buyer backs out of the deal for reasons not covered by the contingencies, the seller may keep the earnest money.

How much earnest money should I offer?

The amount of earnest money required can vary depending on the seller and the market. Generally, earnest money is around 1-2% of the purchase price of the home.

Can I get my earnest money back?

If the sale falls through due to contingencies or other reasons, the buyer may get their earnest money back.

When do I need to pay earnest money?

The earnest money is typically paid when making an offer on the property.