Understanding Earnest Money

06/29/23  |  Emma Bird

A Crucial Element in Real Estate Transactions

When it comes to purchasing real estate, navigating the complexities of the process can be daunting. One crucial aspect that both buyers and sellers should understand is earnest money. Often referred to as a good faith deposit, earnest money plays a vital role in real estate transactions. 

  1. Definition and Purpose: Earnest money is a sum of money provided by the buyer to the seller as a sign of their serious intent to purchase the property. It demonstrates the buyer's commitment and serves as a guarantee to the seller that the buyer is financially capable and genuinely interested in proceeding with the transaction. Earnest money acts as a form of security and protects the seller from a buyer backing out without a valid reason. Earnest money counts toward your downpayment on the property and goes toward your final purchase amount. 

  2. Amount and Payment: The amount of earnest money required can vary depending on factors such as local market practices, the purchase price of the property, negotiations between the buyer and seller, and how much the buyer is putting down in terms of downpayment. Typically, it is a percentage of the purchase price, often ranging from 3% to 5% of the total amount. The payment is usually made in the form of a personal check, cashier's check, or wire transfer, and it is deposited into an escrow account.

  3. Escrow and Disbursement: Once the earnest money is submitted, it is held in an escrow account managed by a third party, typically the listing agent's brokerage however sometimes the title company or an attorney. This ensures that the funds are securely held until the completion of the transaction or until the terms of the contract are not met. In the event of a successful closing, the earnest money is applied towards the buyer's closing costs or down payment. However, if the deal falls through due to contingencies outlined in the purchase agreement, the earnest money is returned to the buyer.

  4. Contingencies and Forfeiture: Real estate contracts include contingencies that must be met for the transaction to proceed. These may include satisfactory home inspections, mortgage approval, or the sale of the buyer's current home. If any of these contingencies are not satisfied within the specified timeframe, the buyer may have the right to terminate the agreement and have their earnest money refunded. However, if the buyer backs out without a valid reason, the seller may be entitled to keep the earnest money as compensation for the time and effort lost.

  5. Negotiating Earnest Money: The amount of earnest money is negotiable between the buyer and seller during the offer stage. A higher earnest money deposit may strengthen the buyer's offer, signaling their seriousness and financial capability. Alternatively, a seller may accept a lower earnest money amount if they are confident in the buyer's commitment. Negotiating this aspect of the transaction requires careful consideration and should align with local customs and market practices.

Earnest money is a critical element in real estate transactions, providing assurance to sellers and demonstrating a buyer's commitment to the purchase. Understanding how earnest money works and its significance can help both buyers and sellers navigate the complexities of the process more effectively. By approaching earnest money with knowledge and awareness, parties can protect their interests and foster a smoother and more successful real estate transaction.