What Is Earnest Money?

Once a buyer and seller sign a purchase agreement or sales contract, the buyer makes an upfront deposit, known as earnest money. The funds are delivered to an escrow account, not directly to the seller. That account is maintained by either a real estate attorney, a title company, or a real estate agent or broker, and it serves as a neutral third party in the transaction. “What is escrow,” you may wonder? Escrow, which acts as a secure holding place, helps ensure a fair and transparent exchange between the parties involved. Earnest money deposits are delivered via personal check, certified check, or wire transfer to the escrow company, which helps protect both the buyer and seller throughout the process.

The earnest money deposit doesn’t guarantee that the purchase will happen or obligate the buyer to pay the sale price. It does require the selling party to take the property off the open market for a set period of time, allowing the buyer to secure financing and conduct a property appraisal and inspection. If the deal does proceed to closing, then the earnest money deposit is applied to the buyer’s portion of the down payment and closing costs as funds allow.

The purchase contract will have specific language regarding the terms and the time frame that the earnest money deposit — and the contract itself — is valid. These terms benefit both the seller and the buyer. Typical language in a home purchase agreement or sales contract will include: 

• A set deadline: This is the time by which the deal must be completed — the buyer must finish their due diligence on the property during this time and secure the mortgage loan. If the buyer can’t secure funding or walks away from the deal, the earnest money deposit is forfeited. These timeliness clauses and loan contingencies protect the seller from having their property sit off the market for extended periods of time. The buyer should have a preauthorization letter from their lender to best ensure that they will secure the eventual mortgage loan.
• The estimated value of the property:  The estimated value of the property will include validation of its current condition. If an inspection turns up issues not mentioned in the real estate contract and the buyer and seller can’t work out a resolution, the earnest money deposit can be returned to the buyer from the escrow account. 

How much earnest money should I put down? 

This good faith deposit can range from 1% to 5% of the sales price. However, real estate investors or buyers in hot real estate markets sometimes offer larger earnest money amounts. This can help give them an edge in a competitive purchasing situation. 

When do you put down earnest money?

Earnest money deposits can help you rise to the top of the pack in an active market. But do not put down money until you’re sure that it’s the property and price you want. The whole process of earnest money or “good faith money” is all about that “good faith.” If you don’t secure financing, sellers can keep the money and sell the house to somebody else. As long as you buy the house or reach an agreement during due diligence, it’s not extra money going to the seller. It’s just an upfront deposit.

When you wire money, make sure to call the title company to confirm the wire instructions. Wire fraud is common! Additionally, make sure to save the acknowledgment of receipt.

When can my earnest money deposit be refunded? 

Deposits can be returned to the buyer if:

1. The inspection turns up issues not previously disclosed that have a material effect on the property’s value. 
2. The mortgage lender will not fund the loan and the financing contingency has not yet passed. 
3. The seller decides to terminate the deal for any reason once the purchase price has been contractually agreed upon.

Earnest money deposits can remain to the seller and not be refunded if:

1. The buyer discovers a material problem with the property after the time frame has passed and wants to walk away from the deal.
2. The buyer obtains full mortgage funding, meeting the financing contingency, but then decides to walk away from the deal anyway.
3. A contingency removal form is filed by the buyer specifically removing one or more of the terms of the purchase agreement, then walks away from the deal. 
4. If a buyer walks away from a purchase agreement or sales contract in a timely manner, most legal jurisdictions mandate that earnest money deposits be returned to them from the escrow company within 48 hours. Depending on the terms of the purchase agreement and local regulations, both the buying and selling parties may need to sign a form and send it to the escrow company before the earnest money deposit can be released. 

Contingencies that can affect earnest money refunds include:

Home inspection contingency

A home inspection that turns up major issues or indicates a property may need extensive repairs can be a reason for a buyer to back out of a deal. If they can show that a home inspection demonstrates problems, they can submit a notice to the seller that they don’t want to move forward with the purchase. In this case, the earnest money is returned. The home inspection contingency is an important one that shouldn’t be overlooked.

Appraisal Contingency

If a property is appraised at a lower value than its selling price, the buyer and seller will have to negotiate a new price. The two parties will need to agree or back away from the deal. Walking away in this instance would not require losing earnest money, and the deposit should be returned.

Financing contingency

Buyers who are unable to secure financing can get out of a real estate deal if there’s a financing contingency in the contract. Typically, a buyer must submit in writing that they were unable to obtain financing within a certain time frame to get their earnest money deposit back.

Clean title contingency

When buying a property, it’s important to do a title search to ensure you can legally purchase it and that no one else has a lien on it. A clean title contingency would allow a buyer to get their good faith money back if the property’s title comes back with any liens.

Selling contingency

Some real estate contracts may have a selling contingency. This allows a buyer to walk away from a deal if they’re unable to sell their home or another property they might need to unload before moving forward with the purchase. A selling contingency lets a buyer get their earnest money back.

Example of Earnest Money

Let’s look at two examples of earnest money — one that gets a refund and one that doesn’t — to get a better understanding of how it works:

Refund example: Eric has put good faith money down to buy a home in another state where he’ll be moving soon. During the home’s appraisal, Eric finds out that the home he wanted to purchase for $250,000 is only appraised at $200,000. He attempts to negotiate with the seller, but they don’t agree with the appraisal and don’t want to take less. Eric is entitled to walk away from the deal and receive his good faith money deposit back in full.

No refund example: Jill’s rental agreement is up next month and she’s found a place she can buy for a similar mortgage payment to the rent she’s used to paying. To get the seller to take the property off the market, Jill provides an earnest money deposit. After discussing her upcoming move with her current landlord, she finds out that they are willing to keep her rent the same for the next year if she will stay.

Jill decides she doesn’t want to deal with the hassle of moving, so she backs out of the real estate deal. In this case, Jill won’t get her earnest money back because she’s not going through with the deal due to issues with the property but for circumstances in her own life that have changed.

What Happens if There’s a Dispute? 

In the event of any dispute between the seller and buyer over a failed deal, the earnest money deposit will be held in escrow until the dispute is settled. In most U.S. states, arbitration or mediation will be the necessary first step to settle any dispute, with the purchase agreement or sales contract being the core document of evidence. That means that experiencing a change of heart or a change in circumstances simply isn’t suitable evidence for returning the deposit. State laws also dictate how the escrow company — always a neutral third party — must handle the process of participating in dispute resolution.

During this time, the earnest money deposit is earning interest in the trust account where the monies are held. If interest accrues in the escrow account in an amount over $5,000, whichever party is due the earnest money will need to file Form W-9 with the IRS to obtain the accrued interest.

If a dispute cannot be settled through arbitration, the matter will go to small claims court (for smaller earnest money deposits) or a general jurisdiction civil court. Going all the way to court is rarely seen in practice, as the expenses and time spent will generally outweigh the benefit to either party.

How Do You Lose Earnest Money 

To receive earnest money back on a real estate deal, you must comply with the contingencies in the contract. A buyer who gets cold feet and simply decides they don’t want to go through with a deal won’t get their earnest money back. 

Additionally, you can lose earnest money if you fail to meet the timelines in the contract. For example, if the home inspection contingency states that you have 10 days from the time of the home inspection to back out of the deal but you wait 14 days from the time of the home inspection, it is unlikely you will get your earnest money back.

Make sure you fully understand your real estate contract before you put earnest money down. This prevents any misunderstandings about the money later.

Who Keeps Earnest Money if a Deal Falls Through 

When it comes to real estate, falling through on a deal isn’t something anyone wants, but unfortunately, it does happen. So who keeps the earnest money when a real estate deal falls through? The answer to this question depends on the language of the contract between the buyer and seller, as well as the reason for the agreement not going through.

The earnest money deposit is given by a buyer to a seller that serves as evidence of good faith while in a real estate transaction. It is typically held in an escrow account by the title company, an attorney, or other third parties who is not involved in the transaction.

The most common reason for a real estate deal to fall through is that the buyer is no longer able to purchase the property. In this case, the earnest money may be refunded to the buyer. If the buyer is in breach of the contract, the earnest money may be forfeited.

If the seller is the one who is in breach, the earnest money may be refunded to the buyer, depending on the state’s laws. In some states, the buyer has the right to sue the seller for damages due to the breach. 

On the other hand, if the deal falls through due to a mutual agreement between the buyer and seller, the earnest money could be split between the two, or the deposit may remain in the hands of the third-party escrow holder.

How To Protect Your Earnest Money Deposit

While there are benefits to putting an earnest money deposit down on a property you’re looking to buy, you need to ensure you take steps to protect your money. You can take these precautions if you want to get your earnest money back if a deal falls through:

• Put contingencies in the contract: Contingencies mean that you can back out of a deal without losing your earnest money if the home inspection determines the house has material damages that need to be addressed or the appraisal comes in at a lower value.
• Read the contract: You have to look over the contract thoroughly and adhere to any timelines for getting a home inspection or appraisal. You likely have a time limit for walking away if something about the deal isn’t right.
• Choose the right money holder: You need to use a reputable company to hold the earnest money in escrow. It’s never recommended to give the money directly to the seller. Find an escrow company, legal firm, or title company to handle earnest money so you don’t have any issues getting it back if necessary.

Learn More About Earnest Money

If you’re considering making an earnest money deposit on a property, read these articles to learn more about how it works:

Home Purchase Fall Through? Don’t Panic: Here’s How to Get Your Earnest Money Back

An Investor Answers: As a Wholesaler, Should I Put an Earnest Money Deposit Down?

7 Ways to Get Your Offer Accepted in a Hot Market

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