What is earnest money?
You might have heard this term thrown around by your real estate agent, mortgage professional of choice, or even your homeowner friends. You might know that it can cost a few hundred to multiple thousands of dollars. Maybe you’ve even heard it paired with the ultra-intimidating mortgage term, “escrow?”
The fact is, while “earnest money” can sound a little hairy, it can be a fairly straightforward and ultra-important part of the homeownership journey.
That’s why we’re taking the time to really explain earnest money.
So, let’s explore what earnest money is, how you can determine the right amount, how its paid, and more. Together.
Earnest money: Funds that you, as the buyer, put down to show you’re serious about buying a seller’s home. You might also hear earnest money called a “deposit” or “good faith money.”
You’ve heard the term “put up or shut up,” right? Sure, it’s a little rough around the edges, but it’s truly one of the best ways to explain earnest money.
When you put down some cold, hard cash, the seller knows you’re actually ready to buy. That’s the job of earnest money. You can differentiate yourself from all the other people who are simply shopping around.
This is also why you might want to only put down earnest money when you’ve found a home you’re serious about. It’s not typically something to just throw at a property you’re still unsure of.
So, you’ve found your dream home and you’re ready to put down some earnest money. How much might you expect to pay?
The unfortunate answer is that it depends. Usually, in a typical market, the amount will fall between 1% and 2% [https://www.investopedia.com/terms/e/earnest-money.asp] of the home’s total purchase price. But, in especially hot real estate markets, you might be expected to pay between 5% and 10% of the home’s total purchase price.
To make it even more complicated, some sellers prefer nice, round numbers—say, $10,000.
And while it can be tempting to put down as little as possible, remember that a seller might interpret a higher amount as greater interest. But you probably should never, ever stretch yourself beyond your budget! No home is likely worth financial stress or even ruin.
So, to sum up, specifics will be based on your local real estate market, the price of the home, and your personal financial situation.
Because the right amount can be so nebulous, you might want to call in reinforcements.
Some buyers will work with a real estate agent or home finance professional to determine an acceptable amount to put down. These pros will have plenty of experience in earnest money for comparable sales, and they might even know how to negotiate on your behalf.
There are also some online earnest money calculators you can play around with to get a general idea. But if you’re serious about a home, there really may not be a substitute for real-world, human experience!
Once you’ve determined the right amount, it’s time to make a payment.
Earnest money is typically paid into an escrow account.
Escrow account: A holding account managed by a neutral third party. When it comes to earnest money, the third party might be a real estate brokerage or title company.
There are usually a few different options for payment. So, you might have some flexibility, whether you prefer to write a check or wire funds. The company controlling your escrow account will have more specific instructions.
The payment timeline can also vary. Some contracts have very specific stipulations, like monthly payments, so be sure you are crystal clear on the agreement before entering.
Once your earnest money and offer to purchase have been accepted, the home will likely be taken off the market, appraised, and perhaps inspected. If any red flags arise? Don’t worry! You typically haven’t closed or committed to purchase just yet.
If you have valid reasons to back out of the deal, your earnest money should be returned to you in most cases. Keep in mind that the contract will spell out what is and isn’t “valid”, so you likely will want to read any agreements thoroughly before signing on the dotted line. The stakes can be high, here. If you pull out without a valid reason, you’ll likely forfeit your earnest money.
If all goes well with the appraisal and/or inspection, or if you decide to go through with the purchase anyway, your earnest money will be applied to your down payment amount at closing costs, or the purchase price. Cha-ching!
At first blush, earnest money may sound a little intimidating. And don’t even get us started on escrow…
But if you take a little time to understand and explore the concepts, you may pretty quickly find that they’re not so complicated after all.
Just think of earnest money as a good-faith deposit on a home you seriously intend to buy! Then, an experienced real estate or home finance professional can help you figure out the rest.