Why Sellers Require Earnest Money
The Earnest Money deposit shows the Seller that a Buyer is serious—in other words, “earnest” is the Buyer's intention to purchase the property. The point of earnest deposit is to stop would-be buyers from making offers on multiple houses they’re interested in, which would result in those properties temporarily taken off the market until the Buyer commits to one of them. For this reason, it’s unusual for a Seller to entertain an offer on their house without it being backed up by a deposit which the Buyer could lose.
If the sale proceeds successfully, Earnest Money can be used for the down payment or closing costs of the sale. It can be looked at by Buyers as putting aside some funds to cover part of these later costs.
Since it is a deposit, there are many situations that allow Buyers to reclaim these funds when things don’t go according to plan.
PLAN FOR EARNEST MONEY WELL IN ADVANCE OF SUBMITTING AN OFFER ON A PROPERTY. THE FUNDS SHOULD BE READILY AVAILABLE FOR WIRE TRANSFER TO "HOLDER OF EARNEST MONEY" (USUALLY THE CLOSING ATTORNEY) WITHIN 5 DAYS OF A BINDING CONTRACT.
How Much Should a Buyer Offer in Earnest Money?
Typically, the deposit required by a buyer will be between 1% and 3% of the purchase price. There are a few factors that can affect this, however, including the state of the real estate market and what the seller requests as a deposit.
A higher deposit can be required if there is a lot of demand in the local market, but on the other hand, a low deposit might be accepted if there isn’t much demand. In some cases, a higher deposit will lead to an offer being accepted. Higher deposits could also lead to the seller being more flexible on other terms in the offer.
What Happens to the Earnest Money Deposit?
When an offer has been accepted, a purchase agreement for the house will be executed. The Purchase and Sale Agreement will state "Holder of Earnest Money" which is usually the closing attorney or Buyer's real estate agency. The Holder of Earnest Money will keep it in an escrow account. The earnest money will be accounted for at the time of closing.
How Does Earnest Money and Down Payment Differ?
While they both contribute to the purchase price of the house, the earnest money is security for the seller, while a down payment is money a Buyer has to put towards the purchase price. The balance of a Buyer’s funds for purchasing a house will come from the procurement of a mortgage.
Is It Possible to get the Earnest Money back?
There are many situations that will allow Buyers to get their earnest money deposits back. When things go wrong, and the deal falls through, Buyers will get their money back most of the time.
There should be contingencies in the contract to allow for situations where the buyer can walk away with the earnest money returned to them. Common contingencies would include finding problems with the house when it is inspected or the buyer failing to secure financing for the purchase price.
If problems are found during the home inspection, the buyer can choose to cancel the offer, renegotiate the price, or have the seller rectify the problem before they proceed. If the buyer is not able to proceed with the sale because they cannot get the financing, they also would be able to get their earnest money returned.
Can You Lose Your Earnest Money Deposit?
Yes, buyer’s absolutely can lose their earnest money deposit—otherwise, what would be the point of having one? Buyers can forfeit their earnest money when they don’t pay attention to the terms of the contract.
Here are the most common ways buyers can lose their deposit:
They don’t respond in writing for extensions they have in the contract, such as a home inspection or financing.
They get cold feet and just walk away from the sale.
They find another property they like better and don’t proceed.
They decided to put up a nonrefundable deposit to make their offer more attractive to the seller
Can Earnest Money be Wired?
Yes, and as many real estate transactions move toward digitization, electronic earnest money deposits (EMDs) are of particular interest for brokerages and agents. Earnest, for instance, is a digital platform that allows for the secure deposits of funds from buyer directly to escrow holder. The app provides a fully digital, closed network for earnest money transactions—no physical checks required. It’s also connected to more than 12,000 banks nationwide with banking-level security and encryption.
Final Thoughts on Earnest Money Deposits
Plan for Earnest Money well in advance of submitting an offer on a property. The funds should be readily available for you wire to "Holder of Earnest Money" (usually the closing attorney) sometimes within 3 days of a binding contract. Note: If you need to withdraw money from a 401 or similar retirement account, this could take weeks.
There are situations where earnest money could be more significant. For example, a builder will usually require a buyer to put down a larger earnest money deposit. It is not uncommon for a builder to require 10% of the purchase price. At times, they also require the ability to use the funds and not have them held in an escrow account. Giving funds to a builder can be somewhat risky if they are not financially sound.