What is Earnest Money?

Earnest Money Defined

If the word “earnest” is defined as showing sincere and intense conviction, then “earnest money” can be considered the good faith deposit in a real estate transaction that shows a buyer’s sincere and intense conviction (interest) to purchase the home upon agreement of a signed contract. 

Essentially, earnest money is a deposit a buyer makes to the home seller via an escrow account until other vital processes in the home buying timeline can be completed. Earnest money buys time to get financing squared away, for title searches, and for property appraisals and home inspections to take place. In the interim, the seller is required to take the home off the real estate market while these actions are underway. 

How Much and Where Is It Kept?

Typically, earnest money is due via certified check or wire transfer within three days of a signed real estate agreement. The amount can vary widely between 1-10% depending on the housing market and other factors. Some experts say that in today’s current, overly competitive market, buyers are not only offering over asking price, foregoing inspections and appraisals, but they are also offering much higher amounts of earnest money to get their offers accepted. 

Earnest money is effectively held in escrow until the closing of the real estate transaction is complete. Escrow is an account that is typically held by a third party like a real estate brokerage, a legal firm, or a title company. If there are no hiccups with the financing, inspection, and appraisal processes, the earnest money will then be applied to the buyer’s down payment or toward closing costs. 

Protecting the Seller

Earnest money protects the home seller in that it allows them to take the home off of the real estate market and there is money in an escrow account that says the buyer is seriously interested in buying the home. However, should the buyer’s financing fall through and they are unable to meet the qualifications to purchase the home, the seller may keep the earnest money as sort of a payment for their time and trouble, or potential missed opportunities of taking their home off the market during the interim while the buyer is getting their affairs in order. There is usually a set time allowable for buyers to line up their financing. If for some reason they are unable to secure the agreed upon amount for the mortgage, then the buyer is no longer bound by the contract and may keep the earnest money. This is called a financing contingency.

Protecting the Buyer

On the flip side, earnest money is in place to also protect the buyer’s interests. During the home inspection and appraisal processes, if a problem should arise, the buyer may also walk away from the transaction and retain his/her earnest money paid. Not all home inspections and appraisals that come back problematic are cause for a negated contract. In many cases, potential home repairs and appraisal gaps could work in favor of the buyer to allow for further negotiation of the sales price. 

A Final Word

Whether you are on the buying or selling end of a real estate transaction, there are a few ways to protect yourself. First, always, always, always use an escrow account. This third-party accountability is in place to protect all parties. Second, be sure to know your contingencies, whether they involve financing, appraisals, or inspections– know your rights. Third, stay on track with all of your responsibilities whether you are the buyer or the seller. Pay attention to timelines and expectations. By partnering with a licensed real estate professional, you’ll ensure that these priorities are handled in a timely and well-executed manner. Last, keep everything in writing. Keep an email and/or paper trail of all documents, discussions, agreements, and contracts. This way, should an issue arise with your earnest money or the overall real estate transaction, you are more likely to be covered and protected.