What is earnest money?

When you make an offer on a home, the seller may want some assurance that you’ll go through with the purchase, barring any issues. That’s where earnest money comes in. It’s a deposit that proves you’re serious about buying the home and provides protection for the seller if you get cold feet for reasons not outlined in your purchase agreement. While earnest money is not always required, it can help your offer stand out, which may be crucial to getting a home in a competitive market. Here’s what you need to know. 

Earnest money is a good faith deposit that a buyer provides the seller of a home when they accept the offer. It helps reassure the seller that the buyer is serious about going through with the purchase. 

If you make an earnest money deposit and later change your mind without a valid reason, you could lose the money. If everything goes as planned and you buy the house, your earnest money goes toward your down payment or closing costs. 

Your purchase agreement protects you in case you need to walk away for certain reasons. For example, if the home inspection reveals major issues, the house appraises for less than the purchase offer, or your financing falls through, you can typically back out and have your earnest money refunded. 

Your purchase contract will specify when earnest money is due, usually within three to five days of signing the contract. You should have the money ready to go when you make an offer. You’ll make out the check to a third-party escrow or title company, which will hold the earnest money in an escrow account so the seller can’t run away with the funds. 

There are a few reasons to pay earnest money. 

1. Earnest money is a show of good faith that you intend to go through with purchasing the home. 
2. Earnest money shows evidence that you can afford to purchase the home. 
3. Earnest money compensates the seller if you get cold feet.

Often, the purchase contract requires earnest money. If you don’t pay earnest money, it will likely void your offer. 

Typically, earnest money ranges from 1% to 3% of the home purchase price. But you can often negotiate the amount of earnest money with the seller. If there are multiple offers on the home, it may be wise to offer more money. 

As long as you abide by the contingencies in your contract, you won’t lose the earnest money if you back out of the purchase. And if you go through with it, you’ll just have fewer costs to worry about on closing day. But if you’re making offers on multiple houses, and there’s a chance you’ll lose your deposit, you may want to negotiate a lower amount. (A high-yield savings account is a great way to grow your deposit until you need it — right now some banks are offering rates higher than 5%.)

Earnest money is refundable based on the contingencies in your home purchase agreement. That means that if certain requirements of the contract are not met and you decide to walk away, your earnest money deposit will be returned to you. Your real estate agent can write any contingency into your offer, but fewer contingencies make the offer more appealing to the seller. 

There are a few types of contingencies that are commonly written into purchase contracts:

• Issues with the home inspection: It’s a good idea to protect yourself with a home inspection contingency. That way, if the home inspection uncovers issues that require repair, you can ask for an amendment to the contract that requires the seller to fix them or lower the price. You can also decide to walk away and get your earnest money back. 
• Low appraisal: Most lenders won’t offer a mortgage for more than the appraised value of the home. An appraisal contingency protects you from having to pay the difference between the appraised value and your offer. If the home appraises for less than the price you offered, you can back out and get your earnest money back. 
• Financing issues: Even if you were pre-approved for a mortgage when you submitted your offer, you could ultimately be denied a mortgage. It’s essential to write a mortgage contingency into your offer if you’re relying on a mortgage loan. That way, if you don’t get the financing you need, you can get your earnest money back. 
• Failure to sell existing home: If you need to sell your current home before you can afford your new home, you can put a contingency in your offer that allows you to back out should your current home fail to sell before closing day. That would allow you to get your earnest money back if you can’t find a buyer. 

If you walk away for other reasons, you’ll lose your earnest money deposit. You’ll also risk losing your earnest money if you don’t follow the timeline outlined in the contract, since that would give the seller permission to walk away. On the other hand, if the seller terminates the purchase for reasons not stated in the contract, they’ll have to release the earnest money back to you. (You can also then sue the seller for breach of contract.) 

• Keep the money in an escrow account: You should deposit the money with a neutral third party, like a title or escrow company, or a real estate attorney. If there’s a dispute, your money will stay in the escrow account until it’s resolved. This keeps your money safe from theft. 
• Take other steps to prevent fraud: Make sure to check that the company or individual holding your funds is properly licensed. And send your earnest money securely: If the escrow company doesn’t have a secure online portal, it’s best to use a certified check. To prevent wire transfer scams, never receive wire instructions via email. 
• Account for contingencies: You should always write an inspection contingency into your offer. Unless you’re paying cash, you should also write appraisal and mortgage contingencies into the offer. If there are other reasons why you might not be able to complete the purchase, make sure to get them in writing. 
• Stick to the timeline: Your purchase contract will include deadlines for certain processes, like getting a home inspection. Make sure to stick to the timeline, or the seller could cancel the contract and keep your earnest money. 

When you find your dream home, earnest money is an important way to prove your commitment to the seller. It may seem like a lot of money to risk, but as long as you account for contingencies and follow the rules in your contract, you don’t have to worry about losing your earnest money. And if you go through with the sale, the money goes toward the purchase — a win-win.

Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.

This article was first published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at [email protected].