What is earnest money and how does it work?

An earnest money deposit is the first of several cash outlays you make when you buy a home. Homebuyers offer this deposit upfront to show the seller they’re serious about buying the property and to make their offer stand out in competitive markets. The deposit is typically 1% or 2% of the home’s sales price; given that the median home price in the U.S. is around $420,000, your earnest money deposit could be $4,200 or $8,400. The money is usually returned to the buyer at closing (and put toward closing costs).

What is earnest money and how does it work?

Earnest money, which is also referred to as a good faith deposit, is an initial deposit from a homebuyer to a seller made in conjunction with a purchase agreement for the home. 

An earnest money deposit is part of the buyer’s offer, and it has two purposes:

• Consideration: It makes the contract binding by serving as the buyer’s “consideration,” or thing of value, offered in exchange for the seller’s promise to sell the home. 
• Serious commitment: Earnest money tells the seller that the buyer is so serious about buying the home that they’re willing to back up their commitment with cash. Without an earnest money deposit, a seller would be wary about taking their home off the market while waiting for the sale to close, especially in a competitive real estate market.

The buyer (or their agent) can deliver the earnest money along with the buyer’s offer, or they can wait until the seller has accepted the offer — the buyer will specify which delivery method they prefer, and the amount of the earnest deposit, in their offer. In either case, the home is officially under contract once the seller accepts the earnest money.

The money is not yet the seller’s at this point in the home purchase process. In a typical real estate transaction, where the buyer and seller have broker representation, the seller’s broker usually holds the check in an escrow account until closing. However, that’s negotiable — if the buyer and seller agree, the buyer’s broker can escrow the funds instead.

Shortly before closing, the broker sends the funds to the closing agent, who credits it toward the cash due from the buyer at closing.

How much earnest money do you need?

You can decide for yourself how much earnest money you want to offer the seller, but 1% to 2% of the purchase price is typical according to REALTOR.com, though in some cases you may need as much as 10%. Some factors to keep in mind:

Local custom

In some locations, it’s customary for buyers to pay a fixed amount rather than a percentage of the purchase price. Your agent can advise you on which is more common for your real estate market and how much buyers typically pay. 

Home’s desirability

You might offer 1% to 3% for a modest, lower-priced home or a home that’s not likely to attract many buyers, such as a fixer-upper. Without other offers, the seller might be motivated to complete a sale quickly, even if it means starting over with no compensation if the buyer backs out.

A more expensive home, on the other hand, warrants a higher amount of earnest money. Otherwise, sellers might not think it’s worth the risk of taking the home off the market for a buyer who doesn’t have much invested.

How much you can afford to lose

In the slight chance that you would forfeit your earnest money rather than complete the sale, consider how losing the funds would affect your finances.

You probably won’t go into your sale planning to default, but some circumstances make that preferable to going through with the sale. Say, for example, you offered to buy the home as-is but ordered an inspection anyway. If the home inspection revealed serious defects the seller couldn’t have known about (and so wasn’t responsible for disclosing) you might have less to lose by forfeiting your earnest money deposit than by purchasing a home in need of extensive repairs.

What is the difference between earnest money and a down payment?

The earnest money deposit is an upfront deposit, and the down payment is a subsequent deposit. So in practice, earnest money is an advance on the down payment due at closing. Both get credited toward the purchase price, and neither is paid to the seller until closing unless the buyer forfeits the earnest money by canceling the sale outside of their contingencies. 

That said, the earnest money and the down payment are listed separately on the closing disclosure buyers and sellers receive before closing. The disclosure lists the down payment as cash due at closing. It lists the earnest money as credit toward cash due at closing. 

When is earnest money refundable?

Your sales contract has all the terms of your agreement with the seller, including the circumstances under which you may terminate the purchase contract without risking your earnest money deposit.

Those circumstances are called contingencies. They’re not automatic — you select any you hope to include when you prepare your offer, and the seller accepts them by accepting your offer.

Common contingencies include:

• Financing: This allows you to terminate the sales contract if you’re unable to get the type of mortgage or other financing you want, or as much as you want, as indicated in the purchase contract, by a specific date.
• Appraisal: The appraisal contingency lets you terminate the sale if the home appraises for less than your accepted offer. In addition to protecting you from overpaying, it supports the financing contingency in that the mortgage lender won’t loan you more than a certain percentage of the home’s appraised value.
• Inspection: A home inspection contingency can release you from the sale if the inspection shows the home’s condition to be unacceptable and you’re unable to negotiate a satisfactory resolution with the seller.
• Sale: If you need to sell your current home to buy the one you want to purchase, and your current home is already under contract, a sale contingency lets you out of the contract on the home you want to purchase if the sale on your home falls through or fails to settle by a specific date. This also supports the financing contingency if your new loan is contingent on paying off an existing one.

Earnest money is also refundable if the seller breaks the contract. However, the seller can have contingencies of their own. 

The sale contingency is a standard one for sellers. While sale contingencies keep buyers from being unintentionally saddled with two homes, the contingencies protect sellers from winding up without a place to live. 

Refundable earnest money is returned to the buyer within a reasonable time after the contract terminates.

How to protect your earnest money

Whether your earnest money deposit is $1,500 or $15,000, you’ll want to do everything you can to avoid losing it:

• Understand your sales contract: Your real estate agent or attorney will explain how your earnest money will be managed and what your rights and responsibilities are. If you’re representing yourself in the sale, you can still hire an attorney to review the contract with you.
• Honor the terms of the contract: If you breach the contract and the deal falls through as a result, the seller likely will have the right to keep the money. 
• Escrow the money: Turning the funds over to your or the seller’s broker or attorney to be placed in escrow protects the money. Brokers and attorneys are legally and ethically accountable for handling escrowed funds according to the terms of the contract and the law.

Earnest money FAQ

What is the point of earnest money?

The point of earnest money is to make the contract binding and let the seller know you’re serious about buying. If you change your mind about buying the home without good reason, earnest money compensates the seller for their time and trouble to relist the home. 

Who receives the earnest money deposit?

Earnest money is for the seller, to be disbursed at closing or upon forfeiture by the buyer. It’s usually turned over to the seller’s broker or attorney, who holds it in an escrow account until closing.

How does earnest money impact the sale process?

Earnest money helps the homebuyer’s offer stand out, particularly in a competitive housing market. Once the seller accepts, the buyer must fulfill their obligations and complete the sale or risk losing their deposit. At closing, the buyer’s earnest money counts as a credit toward the cash they owe, which has the practical effect of a dollar-for-dollar reduction in the down payment or closing costs owed.

Is earnest money part of the closing costs?

No. Earnest money is an advance deposit credited to the buyer’s cash due at closing. Think of it as a closing credit. When you complete the sale, the earnest money can be applied to closing costs.

Can you lose earnest money on a voided deal?

Yes. If you terminate the sale for a reason other than the allowable reasons detailed in the contract, you may forfeit the earnest deposit. For example, if you don’t have a financing contingency and you back out of the sale because you can’t get a home loan, you’d forfeit your earnest money. Likewise, if the house fails to appraise for the purchase price and you don’t have enough cash to make up the difference, you’ll have no choice but to cancel the home sale and forfeit your earnest money.

Christopher Murray has contributed to the reporting of this article.