What is an Earnest Money Deposit?

Earnest money, also known as a good faith deposit, is a sum of money that a buyer provides as a demonstration of their seriousness and commitment to purchasing a property. It is typically submitted when making an offer to purchase a property and is held in escrow until the closing of the sale.

Here's how earnest money works in a real estate transaction:

1. Making an Offer: When you find a property you want to purchase, you make a written offer to the seller, which includes various terms such as the purchase price, contingencies, and proposed timeline. Along with the offer, you typically provide earnest money as a show of good faith.
2. Amount and Form of Earnest Money: The amount of earnest money varies and is typically a percentage of the purchase price, often around 1% to 3%. The specific amount can be negotiated between the buyer and seller. The earnest money is typically paid in the form of a personal check, certified check, or wire transfer, depending on the agreed-upon method.
3. Escrow Account: Upon acceptance of the offer by the seller, the earnest money is deposited into an escrow account held by a neutral third party, such as a real estate brokerage or an attorney. The escrow agent acts as a custodian of the funds until the closing of the sale.
4. Protection for Both Parties: The earnest money serves as a form of protection for both the buyer and seller. It shows the seller that the buyer is serious about purchasing the property and provides compensation to the seller if the buyer breaches the contract without valid reasons. On the other hand, if the seller fails to fulfill their obligations, the earnest money can be returned to the buyer.
5. Contingencies and Forfeiture: The purchase agreement may include contingencies, such as a financing contingency or inspection contingency, that provide the buyer with certain protections and allow them to back out of the deal under specified conditions. If the contingencies are not satisfied and the buyer chooses to withdraw from the contract within the agreed-upon timelines, they typically have the right to receive a refund of their earnest money. However, if the buyer fails to fulfill their obligations and breaches the contract without valid reasons, they may forfeit the earnest money to the seller.
6. Application to Purchase: At the closing of the sale, the earnest money is typically applied towards the buyer's down payment and closing costs. The amount of earnest money is subtracted from the total funds needed from the buyer at closing.

It's important to review the specific terms related to earnest money in your purchase agreement and consult with your real estate agent or attorney to understand the details and protections involved. The regulations and practices regarding earnest money can vary by location, so it's advisable to familiarize yourself with local laws and customs.