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At the onset of a real estate transaction — whether you are buying a home or investing in a property — the number of costs and fees may seem equally confusing and overwhelming.
It’s crucial that you understand how each of these additional costs factor into securing your transaction.
One such example of an added fee is earnest money.
What is Earnest Money, and How Does It Work?
Earnest money is money put into escrow before closing on a house that shows your interest in purchasing the property. It can also be referred to as a good faith deposit.
Earnest money is designed to protect both parties at the onset of a real estate transaction.
For sellers, it provides protection against the time and money lost if a buyer backs out or breaches the contract once an offer is accepted.
For buyers, it serves to show their commitment to seeing the transaction through to the end, ensuring that they get to purchase a home that they like enough to put an offer in on.
How Do I Know How Much Earnest Money to Offer?
The amount of earnest money required may vary between transactions. In most cases, the average amount of earnest money ranges between 1% and 3% of the total purchase price of the property.
For example, if the house you’re interested in is $300,000, a 2% earnest money deposit would be $6,000.
If there isn’t a predetermined earnest money amount in place when you make an offer on the property, don’t be afraid to offer 1%.
Again, the point of earnest money is to simply show your intent to purchase a property, and doing so does not require you to put a large deposit down.
Earnest Money vs. Down Payment
It's important to not confuse earnest money with a downpayment.
When you obtain a mortgage, you will be required to put down a down payment. This is paid to the lender as a display of your financial commitment to repaying the mortgage in full.
That is the key difference between earnest money and a down payment.
Earnest money is a check written to the seller that is not cashed and is instead held in escrow until the subject transaction closes.
Next, we’ll look at the most commonly asked questions associated with earnest money.
Earnest Money FAQs
Q. Is earnest money refundable?
Earnest money is refundable.
At the end of your transaction, the escrow agent who is overseeing your transaction will return your earnest money to you.
Keep in mind the money only serves as a deposit, meaning you get it back when the transaction is over or if the buyer breaches his or her end of the deal, leading to the deal falling through.
Q. When Can the Seller Keep My Earnest Money?
The seller is allowed to keep your earnest money in the event that you fail to hold up your end of the contract.
For instance, if you decide to cancel your offer on the house, the seller can keep your deposit.
Or, if you breach any part of the contract, thus giving the seller the opportunity to cancel the contract, they can do so while keeping your deposit.
Earnest Money: The Bottom Line
Understanding how earnest money deposits work, especially the fact that they are fully refundable, can help you embrace them as a tool that helps ensure that your transaction goes exactly the way that you want it to.
Earnest money is one of many important details in the house buying process.
To learn more details to improve the likelihood of finding your dream home or finding the perfect real estate investment, continue your real estate education with these resources.
