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Earnest Money — Everything You Need to Know

What you'll learn: Understand what earnest money is and how it’s used

EXPECTED READ TIME: 5 MINUTES

Purchasing a home is exciting, as well as a big financial commitment. Once you find a property that you love, it's time to put in an offer with an earnest money deposit. In this article, we'll cover the most common questions homebuyers have. Read on to find out how to protect yourself and your earnest money when purchasing a home.

What is earnest money?

Earnest money represents a deposit made to the seller of the home to show good faith. You are proposing a deposit with your written offer to show you are a serious buyer and want to buy their home.

It’s not something to give lightly. All buyers should be aware of the risks and what happens to their money if the deal falls through.

How much earnest money should I put down?

This is one of those times when the correct answer is "it depends." A good rule of thumb can be anywhere from 1-5% of the home price. Your real estate agent might make a recommendation based on the market. It can also depend on how much you want the home and if they expect other offers.

In a slow market, with a home that has been for sale for many months, you may be able to offer as little as 1% of the asking price as earnest money.

In a competitive market and with a new listing for a hot property, you’ll most likely need to offer more. A higher earnest money deposit demonstrates you are a serious buyer.

Can I get my earnest money back?

The answer is yes, under certain contingencies. A contingency clause is a contract provision that requires a specific event or action to take place for the contract to be considered valid. If the party required to satisfy the contingency clause is unable to do so, the other party is released from its obligations.

One of the most important tasks of a real estate agent is preparing the offer. It's vital to cover every possibility (contingency) in writing so that all parties know what to expect. That’s why selecting a realtor with strong contract and negotiating skills is vital.

When preparing an offer on a home, work with your agent, and talk about contingencies. The contingencies are the "what-ifs" something goes wrong with:

  • Financing
  • Inspections
  • Appraisal
  • Selling your home

Contingencies can vary from state to state in terms of how much time you might have to get inspections and more.

A good agent will be aware of these four common reasons why you'd want to change your mind about buying a house. They’ll also know you’ll want to get your earnest money deposit back.

These are the four most common contingencies:

  1. What if the home doesn't pass inspection? For the most part, a good home inspection will likely turn up a long list of items to fix. That’s even true for new homes. You can have your agent build in a common inspection contingency. If the house doesn’t meet your expectations — you can walk away from the offer and get a refund on your earnest money. For example, what if the roof needs to be completely repaired or it’s discovered the home has termites. Those are two good examples where you may want to renegotiate the selling price. You can also request that the sellers make all the changes. Your last option is to walk away from the deal.
  2. What if the home appraises for less than the selling price? Another excellent contingency to build into the offer is the appraisal contingency. The bank uses the appraiser’s report as an independent third-party review. That way, they can verify the home’s value. Having an appraisal below the selling price means you may not get the funding you need. If the home appraises for less than your offer, it allows you to renegotiate the seller's price.

    Here’s something to keep in mind about appraisals. Government loans from the U.S. Department of Veteran Affairs (VA) and the Federal Housing Administration (FHA) have stricter requirements than conventional loans. That’s why it’s important when making an offer on a home to let the seller know whether you have conventional, VA, or FHA financing. Some properties (especially fixer-uppers) would not pass the strict government guidelines.
  3. What if I don't get approved for my mortgage? A finance contingency is usually a standard clause in contracts. It states you can get all of your earnest money refunded if you can’t get the necessary funding. Even if you have a preapproval, it doesn't guarantee you’ll get the loan from the lender. And that is why it's so important when getting a preapproval to go to a trusted lender like PenFed.
  4. What if I have a home to sell before I buy a new one? Very often, buyers need to sell their current home before they can buy a new one. So, this is another contingency that a seller can decide to accept or deny. It's common to say my offer is contingent upon the sale of my current home. If your sale falls through, this could be another way to get your earnest money refunded.

What happens with the earnest money?

Typically, the earnest money is held in a third party’s escrow account. In many states, that third party is a title company. These funds don’t pass to the seller until the sale successfully goes through. Buyers should not give the earnest money directly to the seller. Instead, they should work with their agent to ensure it gets deposited into an escrow account.

What is an escrow account?

An escrow account is an account managed by an independent third party. They hold the money until the final sale is concluded.

How is earnest money used?

Typically, the earnest money will go towards the down payment of the home. In cases where there may be no down payment, as in a VA loan, the earnest money can go towards closing costs.

Make sure that you keep track of any dates connected to the contingencies during the process. For example, you’ll have a certain number of days for inspections and final loan approval. You don’t want to miss these deadlines because that could mean losing your earnest money deposit.

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