People in the real estate business absolutely love their jargon. During the home-buying process, you’ll likely hear a bunch of complicated phrases tossed around like halibut at the Pike Place fish market. If you’re new to it all, it can be intimidating.
Don’t worry though. A lot of these niche terms you won’t need to memorize, which lets you focus on understanding the big ones, like earnest money, that can really make a dent in your home-buying journey if you don’t have it when it’s time to make an offer. So let’s get crystal clear on what earnest money is and what it means for your home purchase.
What Is Earnest Money?
An earnest money deposit is simply money you put down as a good-faith gesture to indicate you’re serious about buying a house. Typically it’s 1–5% of the purchase price. Here’s how it works.
You know the old storytelling cliché it’s better to show than tell? Well, earnest money is just like that. You’re showing the seller you mean business. It gives them peace of mind to take the next steps forward since it proves you’re sincere—or earnest—about this purchase.
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In return, the seller then agrees to take their home off the market, make it available for inspections, and finish any agreed-upon repairs or provide disclosures to help complete the sale.
While you wait to close on your home, the money is deposited into an escrow account with the seller’s broker, title company or escrow company. This account stows your cash until closing day. Then, the earnest money is subtracted from the amount you owe and often put toward the closing costs.
And in the event that the deal goes sour, you can typically get your earnest money back.
How Much Earnest Money Is Enough?
The short answer is that you need 1–5% of the price that you and the seller agreed upon. The longer answer begins with: “It depends.”
Because it really does depend on a number of factors—mostly related to where you are. In some markets, you’ll need a fixed amount—like $1,000 or $5,000. In other communities, the focus is on the percentage. In really hot real estate markets like Silicon Valley, it’s not uncommon to see six-figure earnest money deposits.
Because that’s not chump change, talk with your real estate agent about how much earnest money they suggest to help you play by the rules in your area.
Now, before we move on, let’s make sure we’re clear that your earnest money is not your down payment. Your down payment is completely separate and should be 10–20% of the purchase price of the home with a 15-year fixed-rate mortgage. That means when you’re calculating how much it’ll cost you to buy a house, lump your earnest money into what you plan to save for closing costs. Earnest money is simply due up front when you make the offer, unlike the down payment and closing costs, which are technically due later when you close on the home.
Do I Get My Earnest Money Back After Closing?
You may be asking yourself, “What exactly happens to my earnest money?”
If everything goes the way it’s supposed to, the earnest money gets folded into your closing costs like bacon bits into pancake batter (trust us—it’s delicious). But you’ll need to be careful and read your contract because there are several ways you could lose your earnest money deposit.
Make sure your agent builds these contingencies into your contract so you can get back your earnest money:
- The home doesn’t get appraised at the offer amount. Maybe you make a $200,000 offer on a home that turns out to be worth only $150,000.
- The home doesn’t pass the home inspection. The home could have significant structural damage or need a new roof and you may not be able to come to an agreement with the seller to make the repairs.
- You can’t get financing. Things happen. Your lender could change ownership or you might encounter another hiccup in the finance process.
You’ll also want to pay attention to the deadlines in the contract. There will usually be a hard date for closing, and your real estate agent can really help you here. If it looks like it may take longer to arrange your financing than you originally thought, you may be able to renegotiate the date to keep things moving smoothly and save that earnest money deposit.
You can often get your earnest money back in cases where no rules of the contract were broken, but keep in mind that there may come a time when you just need to walk away from the deal altogether. Something unexpected—like an accident, a divorce or a dream that causes you to rethink your entire life—could happen. In these cases, be prepared to walk away without your earnest money.
If you need help getting a mortgage to put down an offer on the home of your dreams, talk to our friends at Churchill Mortgage. They’re experts at navigating the mortgage lending process, credit score or not, and will truly put you first.
Work With a Real Estate Agent
While earnest money isn’t too hard to understand, there’s a lot involved in purchasing a home that’s probably (to say it gently) over your head. That’s why the best way to navigate the home-buying process is with the guidance of a trusted professional. Our real estate Endorsed Local Provider (ELP) agents are experts in your local market and have proven track records of excellence. They will take you through the process step-by-step and make sure everything goes right.