Worth Knowing Before You Buy: So…What Is Earnest Money?
If you’ve never bought a home before, earnest money is one of those terms you may hear early in the process and quietly wonder, “Wait…what exactly is that?”
Is it a fee? A down payment? Money you’re giving to the seller? And what happens to it if the purchase doesn’t actually happen?
Earnest money is a deposit made by the buyer as part of a purchase contract to demonstrate good faith and a commitment to the transaction. It is typically held by a third party, such as a title company, escrow company, or real estate broker, according to the terms of the contract. If the purchase closes, the earnest money is generally credited toward the buyer’s purchase funds.
And because earnest money is part of a legally binding transaction, it is worth understanding before you sign an offer.
As a first-time homebuyer myself, I learned this lesson in a way I definitely remember.
When my husband and I bought our first home, we had a bit of a snafu with our earnest money. We were told to mail it.
So…we mailed it.
That turned out to be a terrible idea.
I'll save the full story for another blog post, because there are a few lessons in that experience worth sharing on their own. But it taught me something I think every first-time buyer should know:
When it comes to earnest money, don't make assumptions. Know exactly where it needs to go, who needs to receive it, how much is required, and when it needs to be there.
What is earnest money in real estate?
Earnest money is a deposit a buyer provides after entering into a purchase contract, according to the terms of that contract.
The simplest way to think about it is as a good-faith deposit.
You're telling the seller, in a tangible way, that you are serious about moving forward with the purchase.
It is not the same thing as your down payment, and it isn't simply a fee for making an offer.
Instead, it is part of the money being committed toward the purchase of the home.
The exact amount, deadline, holder, and conditions for its return should be established by the purchase contract. There isn't one universal earnest-money amount that applies to every home purchase.
Where does earnest money go?
This is an important distinction: you generally aren't just handing earnest money directly to the seller.
The purchase contract should identify how and when the earnest money is to be delivered and who will hold it.
Depending on the transaction, it may be held by a title or escrow company, a real estate brokerage trust account, or another designated holder.
In Montana, brokers who receive trust funds have specific requirements for handling those funds, and the Montana Board of Realty Regulation provides that funds may be deposited into the broker's trust account or delivered to the designated holder according to applicable rules.
This is also why I strongly recommend that buyers follow the specific delivery instructions for their transaction rather than assuming they know how the money should be delivered.
And please don't improvise.
If your contract or your transaction team tells you how to deliver the funds, follow those instructions and confirm that the deposit was received.
When is earnest money due?
Your purchase contract should tell you when the earnest money deposit is due.
This is one of the details I want buyers to pay close attention to because signing a purchase agreement and delivering the earnest money are not necessarily the same event.
There may be a specific deadline for delivering the funds after acceptance of the offer.
The amount and timing can vary by contract and transaction, so don't rely on something you heard from a friend or read about in another state.
Read the actual contract you're signing.
If you're unsure about the deadline, ask your Realtor or the appropriate closing or escrow professional before you sign or before the deadline passes.
How much earnest money should you put down?
There isn't a single amount that every buyer should put down.
The appropriate earnest-money amount can depend on the purchase price, market conditions, the type of property, the competitiveness of the offer, and the terms being negotiated.
In some situations, a larger earnest-money deposit may make an offer more attractive to a seller because it represents a greater financial commitment.
But that doesn't mean you should automatically put down as much as possible.
Remember: earnest money is your money.
You need to understand the amount you're committing and the circumstances under which you could potentially put it at risk.
The goal isn't simply to write the biggest check.
The goal is to make an offer that makes sense for your situation and that you fully understand.
Do you get earnest money back?
This is probably the question I hear most often:
“If I don't buy the house, do I get my earnest money back?”
The answer is: it depends.
Your earnest money isn't automatically forfeited just because a transaction doesn't close.
If your contract allows you to terminate for a particular reason, such as exercising an applicable contingency, the contract may provide for the earnest money to be returned to you.
For example, contingencies can give buyers contractual protections if certain conditions aren't satisfied. The CFPB specifically recommends considering contingencies for matters such as financing and satisfactory inspection, because they can provide a contractual path for terminating the purchase if those conditions aren't met.
But that doesn't mean every cancellation automatically results in a refund.
If a buyer breaches the contract or terminates without a contractual right to do so, the earnest money may be at risk.
That's why the phrase “I can always get my earnest money back” is not a safe assumption.
The real answer is in the contract.
When can you lose earnest money?
Earnest money can be forfeited when a buyer fails to perform under the terms of the purchase contract and doesn't have a contractual right to terminate.
Exactly what constitutes a breach, what remedies are available, and what happens to the earnest money depends on the contract and applicable law.
This is one of the reasons I don't want buyers to think of contingencies as little boxes to check without understanding them.
A contingency isn't simply a reason to cancel a contract whenever you change your mind.
It is a contractual provision that can give you certain rights if specified conditions aren't met.
Know what those rights are before you need them.
Earnest money vs. down payment: What's the difference?
These two terms are easy to confuse, especially for first-time buyers.
Your earnest money deposit is provided during the transaction according to the purchase contract.
Your down payment is the amount you're contributing toward the purchase price at closing as part of the financing arrangement.
They're not the same thing.
However, your earnest money may ultimately be credited toward the amount you need to bring to closing, depending on the transaction.
For example, if you put $10,000 into earnest money and the purchase closes, that $10,000 doesn't simply disappear. It is generally credited toward your purchase funds at closing.
Earnest money is a deposit that may be applied to closing costs or the down payment when the sale is finalized.
Best practices for handling earnest money
This is where I think buyers can avoid a lot of unnecessary stress.
Before you submit an offer, make sure you understand:
How much earnest money is required.Know the exact amount you're committing.
When the money is due.Don't assume that “after acceptance” means whenever you get around to it. Your contract should establish the applicable deadline.
Who is holding the money.Know the designated holder and how the funds are supposed to be delivered.
Exactly how to deliver it.If you're instructed to use a specific electronic transfer, check, or other method, follow those instructions. Don't assume mailing a check is acceptable just because it worked for someone else.
Confirm that the funds were received.Keep documentation of your payment and confirmation that the deposit was received.
Understand your contingencies. Know what circumstances may allow you to terminate and what happens to your earnest money if you do.
Know when your earnest money could be at risk. Ask what happens if you terminate outside of a contractual right or fail to perform.
Ask questions before signing.If you don't understand something in the purchase agreement, stop and ask.
That last one might be the most important.
What happens to earnest money at closing?
If the transaction makes it all the way to closing, your earnest money generally becomes part of the funds credited toward your purchase.
In other words, you're not normally paying your earnest money and then paying that same amount again as part of the purchase.
The closing documents account for the deposit as part of the transaction.
Your settlement or closing agent will coordinate the funds needed to complete the purchase, and the final documents will show how the various credits and amounts are applied.
What I want first-time buyers to remember
Earnest money is not something you should be afraid of.
But it is something you should understand.
Before you sign an offer, I want you to know:
How much you're putting down
When it's due
Where it needs to go
Who is holding it
What happens if you close
When it may be returned
When it could be forfeited
And if someone tells you, “That's just how it works,” and you still don't understand it?
Ask another question.
Buying a home comes with a lot of new terminology and a lot of paperwork. You don't need to know everything before you start, but you deserve to understand the commitments you're making along the way.
And if you're a first-time buyer, learn from my mistake:
Don't mail your earnest money just because someone told you to.
Make sure you know exactly how your earnest money is supposed to be delivered, and confirm that it made it where it needed to go.
I'll tell you the rest of that story another time.
That's worth knowing before you buy.
This article is intended for general educational purposes and is not legal advice. Earnest-money requirements, deadlines, contingencies, and remedies vary by contract, transaction, and jurisdiction. Always review your specific purchase agreement and consult the appropriate real estate, legal, title, or escrow professional with questions about your transaction.
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