Earnest Money—How Does It Work?

When buying a home, earnest money serves as a deposit that shows sellers, you're serious about your offer. This good faith deposit demonstrates your commitment to the purchase and can help your offer stand out in competitive markets. But earnest money can be confusing.

If you’ve ever caught yourself wondering what happens to earnest money at closing, you’re not alone. And have you ever asked, “Can earnest money be refunded?” That question and many others plague potential homebuyers, leaving them floundering for answers before they have even started the purchase process. That’s why we’ve explained earnest money deposits—how they're used, when you can get your earnest money back, and how to protect yourself throughout the real estate transaction.

What is earnest money?

Earnest money is a deposit made by homebuyers to demonstrate their commitment to purchasing a property. Unlike your down payment (which goes directly toward your home purchase) or closing costs (which cover transaction fees), earnest money is a show of good faith to the seller that you intend to follow through with the purchase.

When you make an offer on a home, including an earnest deposit, it signals to the seller that you're a serious buyer. This deposit is typically held by a neutral third party until closing and can range from a few hundred dollars to several thousand depending on your local market.

Think of earnest money as your "skin in the game"—it provides financial assurance to sellers that you won't simply walk away from the deal without valid reason. But does earnest money go toward closing? The answer is yes! If the sale proceeds to closing, this money isn't lost—it becomes part of your contribution toward purchasing the home.

How much earnest money is normal?

The standard earnest money deposit typically falls between 1% and 3% of the home's purchase price, though this can vary significantly depending on local real estate customs and market conditions. It’s best to ask a lawyer to help you understand the specifics of earnest money in your state.

Factors that influence earnest money amounts include:

• Market competitiveness: In hot seller's markets, higher earnest money deposits (sometimes 3-5%) can make your offer more attractive.
• Local practices: Some regions have standard practices for earnest money amounts.
• Property value: More expensive homes often require larger deposits.

Remember, while a larger earnest money deposit might strengthen your offer, you should never commit more than you can afford to temporarily hold in escrow—or potentially lose if you breach the contract terms. Don’t neglect to ask a lawyer for assistance before you sign contracts. You could even consider consulting with a financial advisor.

What happens to earnest money at closing?

Once you reach the closing table, your earnest money deposit typically gets applied toward your down payment or closing costs. This is good news for buyers—the money you put down as earnest money doesn't disappear but instead becomes part of your contribution to the purchase.

Here's how the process typically works:

1. When your offer is accepted, your earnest money is deposited into an escrow account held by a neutral third party (like a title company, real estate brokerage, or attorney).
2. This money remains in escrow throughout the transaction period.
3. At closing, the escrow agent applies this money toward your down payment or closing costs as specified in your purchase agreement.
4. You'll see this credit on your closing disclosure document.

So, what happens to earnest money at closing? It seamlessly transitions from being a deposit to becoming part of your payment for the home. The timeline for releasing these funds coincides with your closing date—typically 30 to 60 days after your offer is accepted, though this varies based on your specific transaction timeline.

Can you lose earnest money?

Yes, there are circumstances where you might forfeit your earnest money deposit. This typically happens when a buyer backs out of a transaction for reasons not protected by contingencies in the purchase agreement.

Common scenarios where earnest money might be lost include:

• Missing deadlines specified in the contract
• Backing out of the purchase without a valid contingency
• Changing your mind after all contingencies have been removed
• Failing to secure financing after waiving the financing contingency

A common question buyers ask is, “Can I get my down payment back on a house?" when they're actually referring to their earnest money. To protect your earnest money, most purchase agreements include contingencies—specific conditions that must be met for the sale to proceed. The most common contingencies include:

• Financing contingency: Protects your deposit if you can't secure a mortgage
• Home inspection contingency: Allows you to renegotiate or walk away if serious issues are discovered
• Appraisal contingency: Protects you if the home appraises below the purchase price
• Title contingency: Ensures the property has a clear title

A well-written contract with appropriate contingencies is your best protection against losing your earnest money deposit. Schedule a consultation with your lawyer to give you guidance on how to draft a good contract and have them review your paperwork too!

Who holds the earnest money?

Earnest money is typically held by a neutral third party in an escrow account—not by the seller or the buyer's agent. This arrangement protects both parties in the transaction.

Common earnest deposit money holders include:

• Title companies
• Real estate brokerages
• Escrow companies
• Real estate attorneys

The holder of these funds has a fiduciary responsibility to maintain the money in a separate escrow account and only disburse it according to the terms of the purchase agreement or by mutual consent of both parties.

Earnest money law varies by state, governing the handling of these funds, including requirements for where they must be kept and how disputes are resolved. In most states, earnest money must be deposited within a specific timeframe (often 1-3 business days) after the offer is accepted. But as always, you’ll need to consult your lawyer to learn the exact laws in your state.

Is earnest money refundable?

Yes, earnest money is often refundable, but it depends entirely on the circumstances and the terms outlined in your purchase agreement. Many buyers wonder, "Can earnest money be refunded?" and "Can you get earnest money back?" - the answer is yes, under specific conditions.

Situations where earnest money is typically refundable include:

• The home inspection reveals significant problems, and you're within your inspection contingency period.
• The home appraises for less than the purchase price, and you have an appraisal contingency.
• You're unable to secure financing, and you have a financing contingency
• The seller fails to meet their contractual obligations.
• Title issues are discovered that can't be resolved before closing.

Is a good faith deposit refundable? The answer depends on your contract terms. Scenarios where you might forfeit your earnest money include:

• You simply change your mind after contingencies have been removed.
• You miss important deadlines specified in the contract.
• You find another property you prefer after contingencies have expired.
• You fail to close on time for reasons under your control.

Always read your purchase agreement carefully to understand exactly when your earnest money is at risk and when it's protected. Have your lawyer take a look at the document to make sure the legal terms are correct and above-board.

How to protect your earnest money

Safeguarding your earnest money requires careful attention to your purchase agreement and understanding your obligations as a buyer. Here are some key strategies:

• Include appropriate contingencies that protect you from unforeseen circumstances.
• Know your deadlines and meet them—set calendar reminders for inspection periods, contingency removal dates, and other critical milestones.
• Get everything in writing
• Work with experienced professionals who understand local earnest money practices and can guide you through the process.
• Read your contract thoroughly before signing—understand exactly what could put your deposit at risk.
• Consider consulting a real estate attorney to review your contract, especially for large deposits.

While waiving contingencies might make your offer more attractive in competitive markets, doing so significantly increases your risk of losing your earnest money deposit if something goes wrong.

What if a deal falls through?

When a real estate transaction doesn't make it to closing, what happens to the earnest money depends on why the deal failed.

If the deal falls through due to a protected contingency (like a failed home inspection or financing issues), the buyer is generally entitled to a full refund of their earnest money. However, the process isn't always automatic:

1. Both parties typically need to sign a release of earnest money form.
2. The escrow holder then returns the funds to the buyer.
3. The timeline for refunds varies but usually takes 1-10 business days after the signed release.

The release of earnest money can sometimes become complicated if there's a dispute about who is entitled to the funds. The resolution process depends on your purchase agreement and state laws. Options might include:

• Mediation: Using a neutral third party to help reach an agreement
• Arbitration: Having a neutral party make a binding decision
• Litigation: Taking the matter to court (though this is usually a last resort)

In disputed cases, the escrow holder typically maintains the funds until the dispute is resolved, which can sometimes take months.

Do you always have to pay earnest money?

While earnest money is standard practice in most real estate transactions, it's not always legally required. Some situations where earnest money might be minimal or unnecessary include:

• For Sale By Owner (FSBO) transactions where the seller doesn't require it
• Seller-financed deals with different terms
• Purchases in extremely slow markets where sellers are motivated
• Buyers paying all cash who can close quickly

Some alternatives to traditional earnest money deposits include:

• Letters of intent (though these offer less protection to sellers)
• Larger down payments with faster closings
• Personal guarantees (though these are less common and riskier)

However, skipping earnest money comes with risks—your offer may appear less serious to sellers, potentially putting you at a disadvantage, especially in competitive markets. Most real estate professionals recommend including an appropriate earnest money deposit to demonstrate your commitment and strengthen your offer.

Key takeaways about earnest money

Understanding earnest money is essential for navigating the home buying process with confidence:

• Earnest money demonstrates your commitment as a buyer and strengthens your offer
• The typical deposit ranges from 1-3% of the purchase price, but varies by market
• What happens to earnest money? At closing, it becomes part of your down payment or closing costs.
• Contingencies in your purchase agreement protect your earnest money from being forfeited.
• A neutral third party holds the funds until closing or until the contract is terminated.
• Your deposit is generally refundable if you back out for reasons covered by contingencies.
• Reading and understanding your contract is the best way to protect your earnest money.

How LegalShield can help protect you when you have a real estate transaction

Navigating earnest money deposits and real estate transactions can be complex, and having legal guidance can provide peace of mind throughout the process. LegalShield offers affordable legal protection plans that give members access to qualified attorneys who can assist with real estate matters.

With a LegalShield Membership, you can:

• Get contract review services for your purchase agreement before signing.
• Schedule consultations with attorneys related to real estate law.
• Ask legal questions about your transaction, earnest money, and contingencies.
• Receive guidance if disputes arise regarding your earnest money deposit.
• Get help understanding local real estate laws that might affect your transaction.

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Written by Elyse Dillard, Content Specialist at LegalShield. Elyse creates educational resources about legal and identity theft protection services. She works to make complex legal concepts more accessible to readers and has contributed to numerous articles on the LegalShield blog.  

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