What is an earnest money deposit?

A lot is at stake when buying and selling a home. One way buyers show sellers they’re serious about going through with a home purchase is by putting down a “good faith,” or earnest money, deposit.

This deposit is a key component of a home purchase, but it comes with conditions. Buyers may lose their deposit if they choose to walk away from the home sale or don’t meet deadlines outlined in the purchase agreement. They can protect themselves by adding contingencies to their contract, but sellers may be weary of these conditions, especially in seller’s markets.

What is an earnest money deposit in real estate?

After a seller accepts an offer, the homebuyer will make a “good faith deposit” to show the seller they’re serious about buying the home. This “good faith deposit” is also known as earnest money.

Prospective homebuyers typically make earnest money deposits when they sign the purchase agreement. The money is held in an escrow account with a third-party title company or escrow company until closing. It is sometimes handled by the listing agent or their real estate brokerage.

The buyer should never give the deposit directly to the seller. This precaution ensures that the earnest money goes to the appropriate party according to the details of the purchase contract.

How much earnest money is enough?

The exact amount of earnest money needed will depend on your market and local custom. In some places, it’s negotiable, while in others, it’s a fixed amount. Generally, the earnest money deposit ranges between 1% to 3% of the home’s purchase price. Larger earnest money deposits can also act as an incentive to accept a buyer’s offer. If the sale goes through, the money will later go towards the buyer’s down payment and closing costs.

Why does a buyer need to show “good faith”?

Selling a home takes time. The closing process alone can take almost two months. That’s to say nothing of the time that went into preparing the home for sale, or vetting and reviewing potential offers.

Additionally, when a seller accepts an offer, they take their home off the market and forgo the opportunity to receive more, and potentially better, offers from other buyers (unless there’s a kick out clause).

As such, the seller needs some assurance that the buyer is serious about purchasing the home and isn’t going to backout during the closing process. A good faith deposit gives buyers and sellers shared stakes in seeing the purchase through.

Are earnest money deposits refundable?

To protect their earnest money deposit in case something goes wrong with the sale, home buyers can add contingencies to their offer, like an appraisal contingency or home inspection contingency. These clauses allow a buyer to back out of the purchase contract under specific conditions without losing their money. 

Additionally, the earnest money is returned to the buyer when the seller decides to end the sale for any reason.

In certain areas, like Texas, buyers get an option period of about a week after signing the contract during which they can back out of the sale and get their earnest money deposit refunded for any reason.

When does a buyer lose their earnest money deposit?

There are some instances when a buyer can lose their earnest money deposit, such as when:

• The buyer fails to meet deadlines: If a buyer fails to meet specific deadlines outlined in the purchase contract, they could forfeit both the deposit and the home. It’s important to note that these deadlines aren’t meant to trick the buyer into losing their deposit, and a good real estate agent will help the buyer navigate them.
• The buyer walks away: If the buyer has a change of heart and decides against purchasing the home, they typically lose their deposit unless otherwise stipulated in the purchase contract.

→ Learn about when the buyer can walk away after final walkthrough

Are contingencies the best option?

Contingencies help buyers ensure that their earnest money deposit is safe and secure. However, sellers may be reluctant to accept a contingent offer since there’s a chance that the sale will fall through. That’s why in tough seller’s markets or particularly competitive home sales, non-contingent offers win out.

Interested in being a non-contingent buyer? Orchard can help by giving you a guaranteed offer on your current home and an equity advance for your new one. That way, you can drop the contingencies and focus on what matters most: putting forth the best offer on your dream home. Get started with a free home estimate today — our valuations are over 30% more accurate than other leading estimates.

How to protect your earnest money

As a significant percentage of your down payment, your earnest money deposit is a considerable sum. Here’s how to protect your investment.

Understand your contract

Home sale transactions are complicated with many moving parts. It’s also the largest purchase many of us will ever make. Protect your investment and yourself by putting every detail of the home sale in writing and understanding how it works. Your real estate agent or real estate attorney is a great resource for ensuring that your interests are protected.

Abide by your contingencies

Once your contract — including your contingencies — is in writing, follow them. That means that if your home inspection turns up issues, you give the seller notice that you’re walking away within the agreed upon timeframe. If you don’t abide by these details in your purchase contract, you could end up sacrificing your earnest money deposit.

Keep the money in an escrow account

As previously discussed, it’s best practice to keep your earnest money deposit with a third party like a title or escrow company. This will ensure impartiality when disbursing funds. Buyers usually pay their deposit with a certified or personal check or wire transfer addressed to the third party. Funds are held in escrow until closing day.