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. Earnest money deposits are delivered via personal check, certified check, or wire transfer to the escrow company.
The earnest money deposit doesn’t guarantee that the purchase will happen or obligate the buyer to complete the purchase. 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 closing costs or down payment.
The purchase contract will have specific language regarding the terms and the timeframe 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 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 pre-authorization letter from their lender to best ensure that they will secure the eventual mortgage loan.
The estimated value of the property and a validation of its current condition. If the inspection turns up issues not mentioned in the 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 one to five percent 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 can I get my earnest money back?
Deposits can be returned to the buyer if:
The inspection turns up issues not previously disclosed that have a material effect on the property’s value. It is the responsibility of the buyer to negotiate timeliness clause deadlines for the inspection contingency that allow ample time for inspections to take place. If the buyer and seller can’t negotiate a satisfactory conclusion, the buyer can walk away from the contract with the earnest money deposit returned.
The mortgage lender will not fund the loan, and the financing contingency has not yet passed.
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:
The buyer discovers a material problem with the property after the timeframe has passed, and wants to walk away from the deal.
The buyer obtains full mortgage funding, meeting the financing contingency, but then decides to walk away from the deal anyway.
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.
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.
What happens if there’s a dispute?
In the event of any dispute between 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, an 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.
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 absolutely 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.
Head’s up: 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 acknowledgement of receipt.
