Earnest money is a deposit made to a seller that represents a buyer's good faith to buy a home. In most cases, earnest money is delivered when the sales contract or purchase agreement is signed. It is usually about 1%-2% of the purchase cost of the home. Offering more earnest money typically makes you look like a stronger buyer. Therefore, a buyer should offer a high enough earnest deposit to be accepted, but not so high as to put extra money at risk since there’s still a chance that the deal might not go through and the deposit not refunded. Once deposited, the funds are typically held in an escrow account until closing, at which time the deposit is applied to the buyer’s down payment and closing costs.

Earnest money is also known as an escrow deposit or good faith money.

When a buyer decides to purchase a home from a seller, both parties enter into a contract. The contract doesn’t obligate the buyer to purchase the home, because reports from the home appraisal and inspection may later reveal problems with the house that will allow you to cancel the contract. The contract does, however, ensure the seller takes the house off the market while it’s inspected and appraised. To prove the buyer’s offer to purchase the property is made in good faith, the buyer makes an earnest money deposit (EMD).

The buyer may be able to reclaim the earnest money deposit if something that was specified ahead of time in the contract goes wrong. For instance, the earnest money would be returned if the house doesn’t appraise for the sales price or the inspection reveals a serious defect – provided these contingencies are listed in the contract.

Of course, earnest money isn’t always refundable. For example, the seller gets to keep the earnest money if the buyer decides not to go through with the home purchase for contingencies not listed in the contract, or if the buyer fails to meet the timeline outlined in the contract. And, not surprisingly, the buyer will forfeit the earnest money deposit if he or she simply has a change of heart and decides not to buy.

Earnest money is always returned to the buyer if the seller terminates the deal.

Protecting Your Earnest Money Deposit

Prospective buyers can do several things to protect their earnest money deposits.

  • Make sure contingencies for financing and inspections are included in the contract. Without these, the deposit could be forfeited if the buyer can’t get financing or a serious defect is found during the inspection.

  • Read, understand and abide by the terms of the contract. For example, if the contract states the home inspection must be completed by a certain date, the buyer must meet that deadline, or risk losing the deposit – and the house.

  • Make sure the deposit is handled appropriately. The deposit should be payable to a reputable third party, such as a well-known real estate brokerage, escrow company, title company or legal firm (never give the deposit directly to the seller). Buyers should verify the funds will be held in an escrow account and always obtain a receipt. At Grey Duck & BRIX we use TrustFunds, a reputable third-party system that is done electronically.