10. What is Earnest Money?

by Local Title

Earnest money is a deposit made by a homebuyer to show their serious intent to purchase a property. This financial gesture is part of the homebuying process and is intended to demonstrate to the seller that the buyer’s offer is made in good faith. Typically, earnest money is paid when the seller accepts the buyer’s offer, and the sales contract is signed. The amount varies depending on local real estate practices and the price of the home but generally ranges from 1% to 3% of the purchase price.

Once deposited, the earnest money is held in an escrow account managed by a third party such as a real estate brokerage, legal firm, or title company. This ensures that the funds are safely held until the sale either closes or is terminated. At closing, earnest money is usually applied toward the down payment or closing costs. In essence, it’s part of the buyer’s initial investment in their new property.

However, earnest money isn’t just a part of the financial transaction; it also serves as a protective measure for both parties involved. For sellers, the earnest money acts as a safeguard, ensuring that the buyer is committed to the transaction and less likely to back out without a valid reason. For buyers, it’s important to understand that while earnest money can fortify their offer, it’s not without risk. The terms under which earnest money can be forfeited or returned are typically outlined in the purchase agreement.

Should the buyer fail to follow through on the terms of the contract without a legally valid reason, they might forfeit the earnest money to the seller as compensation for the time the property was off the market. Conversely, if the buyer adheres to the contract terms but the sale fails due to a contingency clause (like failing a home inspection), the earnest money is usually returned. Therefore, buyers should carefully review and understand the contingencies before entering into a contract.