15.7% of home purchase agreements were canceled due to buyers’ lack of assurance in 2023. Jacksonville, FL, had the highest cancellation rate, at 26.6%, while San Francisco had one of the lowest, at 6.4%.
Fears of a volatile market and rising mortgage rates can further delay home sales, leaving properties unsold for extended periods.
No wonder earnest money has gained incredible importance in real estate transactions. Earnest money is a deposit a buyer makes to demonstrate their serious intent to purchase a property. This blog will explore earnest money, how it differs from a down payment, and how much you typically need to pay.
What Is Earnest Money?
Earnest money is a deposit made before buying a house to show you are a serious buyer. This payment, also called a good faith deposit, is common in real estate deals.
It allows you to negotiate with the seller to have the home title search, property appraisal, and inspections done before closing. You can get your money back if a home inspector finds major problems or the seller breaks any purchase agreement terms.
How Much Earnest Money Do You Need to Pay?
The earnest money deposit is usually between 1% to 2% of the home’s purchase price but can go as high as 3%. So, for a $345,000 house, this means paying between $3,450 and $10,350. However, it can vary based on factors like local market trends and home prices.
How Does Earnest Money Work?
Once the seller accepts your offer, you will sign a contract that explains how to pay the earnest money. Then, within a day or two, you must deposit the earnest money into an escrow account managed by a neutral third party, like a legal firm or real estate agent.
Is the Earnest Money Deposit Refundable?
You can get a refund of your earnest money in certain situations:
- The seller refuses to fix problems found during the inspection.
- The property’s appraisal is lower than the agreed price.
- The seller fails to provide a clear title.
👉 Whether you get your earnest money back depends on the clauses in your purchase contract.
What Are 5 Key Contingencies for Earnest Money Deposits?
A contingency is a condition that must be met to finalize a sale. Either side can cancel the deal and keep the earnest money if the condition isn’t met. Common contingencies are:
- Mortgage Contingency: If buyers can’t get a mortgage, they can cancel and get their deposit back.
- Inspection Contingency: Buyers can cancel the deal if the inspection uncovers significant problems.
- Appraisal Contingency: Buyers can back out to avoid extra costs if the home’s appraisal is lower than expected.
- Title Contingency: If the seller can’t prove they own the home, buyers can cancel the deal to avoid legal trouble.
- Home Sale Contingency: Buyers can delay closing until they sell their current home to avoid paying two mortgages.
🌟Buyers can add more contingencies but must pay attention to deadlines. Missing deadlines can cancel the contract.
Earnest Money vs. Down Payment
| Aspect | Earnest Money | Down Payment |
|---|---|---|
| Purpose | It shows the buyer’s intent to purchase the property. | This reduces the principal amount borrowed for the mortgage. |
| Timing | Paid when the offer is made. | Paid at closing when the sale is finalized. |
| Amount | 1-2% of the purchase price. | 5-20% of the purchase price. |
| Refundable | Yes, under certain conditions specified in the contract. | No, it’s part of the total purchase price. |
| Held in Escrow | Yes, by a neutral third party. | No. |
What Happens to Earnest Money at Closing?
Earnest money is put into an escrow account until the deal closes. If the deal goes through successfully, the earnest money is applied towards the down payment and/or closing costs, depending on the terms of the contract.
The rest helps with closing costs, which are usually 2% to 5% of the purchase price. The amount of earnest money refunded if the deal falls through depends on the contingencies outlined in the purchase agreement.
How to Keep Your Earnest Money Safe?
Here are the ways you can protect your earnest money:
- Add Contingencies: Include finance, inspection, and defect clauses to protect your deposit if there are major problems or financing issues.
- Meet Deadlines: Follow all contract deadlines. Missing them can result in losing your earnest money.
- Use Trusted Professionals: Work with reliable escrow, title, and law companies, as well as brokers. They help keep your deposit safe according to the contract.
Bottom Line
Earnest money, usually 1%- 2% of the purchase price, is crucial in the competitive homebuying process. Held in escrow until closing, this deposit demonstrates your serious intent to purchase a home and strengthens your negotiating position.
At closing, about 75% of the earnest money is applied to your down payment, with the remainder covering closing costs. Refunds depend on the terms of the contract and are typically related to factors such as failed inspections or loan denial.