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The Importance of (Being) Earnest: Earnest Money 101

October 17 2018
by Leisl Bailey

One US dollar bill on a white background to represent earnest money

If you’re buying a home, no doubt you’ve heard the phrase “earnest money.” So, what is this money?

Is it important? (Yes.) Does it have anything to do with the Oscar Wilde play? (No.)

When buying a home, of course you want to make sure that you don’t overpay or purchase a home with hidden problems. You also don’t want to miss out on the home of your dreams.

That’s where earnest money comes in.

While you can always ask your real estate agent for help understanding, it’s a good idea to have a working knowledge of property transfer essentials like earnest money before partnering with one.

What is earnest money?

People often call earnest money “good faith money.” This is because it essentially acts as an intention of good faith between the buyer and seller of a certain property.

When someone decides to purchase a home, they enter into a purchase contract with its seller. The contract outlines things like the proposed final sales price and the down payment. However, this purchase contract does not legally require the buyer to follow through with the purchase. This is because things like home inspections could reveal problems with the property.

However, the contract often requires that the seller remove the house from the market while the buyer processes the inspections. So, as a promise to the seller that his offer is truly “in good faith,” the buyer usually puts forth earnest money as a deposit.

How much earnest money do you pay?

The amount you pay in earnest money for a deal depends on where you live. There is no national or even state standard—it can vary from county to county and even city to city.

However, a good rule of thumb is that earnest money is typically anywhere from 1% to 5% of a property’s total final purchase price.

Sometimes, sellers might set fixed amounts for earnest money instead of asking for a percentage of sale price or down payment. Sellers who ask for a fixed amount typically require $5,000 to $10,000.

In particularly hot markets or competitive single sales, the amount of earnest money a seller requests to secure the sale can be significantly higher than average. Additionally, a buyer can offer more earnest money to make their offer more attractive to the seller.

Is earnest money required?

No. Note that the earnest money is “required to secure the sale” and not just “required.”

The difference there is that earnest money is not actually a legal requirement of property transfer. As mentioned, it just ensures the seller knows that the buyer is actually serious about the property.

However, notes the Cincinnati Area Board of Realtors, “It is rare that a residential real estate transaction does not include an earnest money deposit.” So be prepared to pay it if you want to make an offer.

What happens to my earnest money?

After the seller accepts an offer, the buyer typically has between one to three days to deposit the money into a protected escrow account. The buyer can pay the earnest money by certified check, personal check, or wire transfer.

The real estate brokerage, legal firm, or title company keeps the funds safe until the sale of the home is final. Then, that company applies the earnest money toward the buyer’s down payment.

To protect yourself in case a deal falls through, only ever give your earnest money to a bona fide escrow company and for a home you fully intend to buy. Never give the money directly to the seller. You should also always ensure that the funds will not be released until the deal closes officially, and always, always obtain a receipt.

If you are the one giving the gift of earnest money, give it directly to the company, rather than the homebuyer.

Sometimes, a family member or friend will offer to pay their loved one’s earnest money to help them purchase a home they love. They can do this regardless of if the loan is an FHA loan or a conventional mortgage loan.

In order to do this legally, however, the lender in the property purchase transaction (usually an escrow company) needs an official “gift letter” from the person giving the money. This letter must state that the family member or friend is giving the money to the buyer and not simply loaning to them.

Can you get your earnest money back?

Sometimes, if the deal falls through, you might be wondering if you can get your earnest money back.

Sometimes you will be able to receive a refund. However, first things first: Always check the fine print of your contract before you sign it.

This is because the laws around refunding earnest money can and often do vary from state to state.

If financing falls through, you will be protected if you have a contingency clause that requires written confirmation from your lender before proceeding with the sale.

If the home fails the inspection, it leaves you in a similar situation with earnest money.

As a buyer, as long as you have an inspection contingency written into your contract, you will be able to cancel the deal and walk away. Typically, you will receive your funds from the escrow account within two weeks.

Unfortunately, if you did not include these contingencies in your contract, it is possible that the seller will be able to keep the earnest money.

Handling Earnest Money as a Buyer (and Seller!)

Remember, earnest money is a promise between two people. It is an act of good faith from the buyer saying, “Yes, I am really interested in this property!” For sellers, accepting earnest money essentially says, “There’s nothing wrong with this home. We should proceed to the sale.”

In order for both parties to fully trust each other, it is essential to involve a high-caliber escrow company to look after the funds while things are in transition.

This responsible choice, partnered with a well-reviewed contract with contingencies for both home inspections and financing, will keep both parties protected while moving forward toward a completed sale.

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Ready to put earnest money down on the home of your dreams? The agents with Clever will help you out—for just one low, flat fee. Call us today at 1-833-2-CLEVER or fill out our online form to get started.