Earnest Money Deposit, what is it & how does it work?

Earnest Money Deposit

Once you find a property that you love, it's time to put in an offer that likely includes an earnest money deposit. In this article, we'll cover homebuyers' FAQs, including what a good faith deposit is, how to determine the amount of your earnest money deposit, and where the funds can come from.

1. What is earnest money when buying a house?

Earnest money (also called a good faith deposit) is an up-front deposit made by a home buyer when making an offer on real estate. Earnest money represents your commitment to the transaction in good faith, showing the seller that you're serious about the property and signals the start of the purchase process.

2. How does earnest money work?

When you write an earnest money check, the funds typically go into a trust or escrow account held jointly by the seller and the buyer. That way, the good faith funds are controlled by a neutral third party, such as a title company or real estate broker, and include limitations that protect both parties. The earnest deposit stays in the account until certain conditions or contingencies are met. It's then released to the appropriate recipient.

Even if you're buying a house For Sale By Owner (FSBO), it's not recommended to give your home buying deposit directly to the seller. Without a reputable title or escrow company, you'll have no protection or way of getting your earnest money back if the sale doesn't go through.

3. What is earnest money used for?

Many homebuyers wonder: Does a good faith deposit go toward a down payment? It often does, but it doesn't have to. Think of your earnest deposit for a house as an advance on the sale. If the deal goes through as planned, your good faith deposit will fold into your down payment. In situations where there may be no down payment, such as with a VA loan, the earnest money can go toward closing costs.

Putting earnest money on the table can also give you some breathing room to finish getting your financing in order.

4. How much should a good faith deposit be?

A good rule of thumb is that an earnest money house deposit can be anywhere from 1 percent to 5 percent of the property price. So how do you decide how much your earnest deposit should be? There are various factors to consider:

• Competition: whether it's a hot seller's market or a wide-open buyer's market
• How many other offers are on the house
• Regulations in your state

Just like an offer over the asking price, a larger deposit on a house can sometimes tip the odds in your favor - especially if your seller sees a lot of interest in their home. Your real estate agent may make a recommendation based on the market and intel they know about the seller.

5. What happens to your earnest money if the sale falls through?

Sometimes a deal can fall through. If that happens and your purchase contract has protections in place, you should be able to get your earnest deposit back. That's why it's so important to work with a knowledgeable lender and real estate agent and have everything in writing in your purchase agreement.

If things don't work out, the earnest funds usually go to whichever party was not responsible for breaking the agreement. Here are some possible scenarios:

6. Is earnest money required?

Not necessarily, but sellers may be apprehensive to accept an offer without a good faith deposit. Think about it: Without earnest money for a house deposit, potential buyers could make as many offers on as many homes as they like - essentially taking all the homes off the market while they decide which one they want most. That might sound great as a buyer, but it's not fair or feasible for the sellers.

When you put in an offer on a home, it should include the amount you have available for your earnest funds. Remember, earnest money benefits both the buyer and the seller.

7. Where can earnest money come from?

Your lender will verify the source of your earnest money mortgage deposit. They want to know that this money really does belong to you and accurately represents your ability to fund a home purchase. When you apply for a mortgage, you'll also submit your most recent bank statements. You should be able to show that the money has been in your account for at least 60 days.

8. What if I don't have earnest money?

Sometimes there are options available if you don't have cash available for a good faith deposit:

• Request a waiver of earnest money in your offer. Just keep in mind it may be harder to appeal to the seller, especially in a competitive market.
• Receive a gift from a friend or family member. (See question 9.)

9. Can earnest money be a gift?

Sometimes a relative or close friend offers to give you money to help buy your home. If the earnest money comes from a gift, you'll need a signed gift letter to show proof of the escrow deposit. The letter will need to include the amount of the gift, the relationship of the donor, and that they do not expect repayment.

Not every mortgage type allows for good faith funds to be gifted. For example, the VA has earnest money verification guidelines that require the money come directly from you. Conversely, FHA earnest money deposit guidelines allow for gift funds.

10. Can you borrow earnest money?

It is not common or recommended to get a personal loan for an earnest money deposit. Besides enticing the seller, a good faith deposit shows a lender you are financially prepared for a mortgage. If you're concerned about coming up with earnest money for a house, it could raise a flag.

The home buying process has many steps. A good faith deposit on a house is key to making a strong offer and getting into the home of your dreams. If you still have questions, contact a loan officer today.

Buying your first home? Learn how to go from curious to closing in our free home buying eBook.