Loading the player...

What is 'Earnest Money'

Earnest money is a deposit made to a seller showing the buyer's good faith in a transaction. Often used in real estate transactions, earnest money allows the buyer additional time when seeking financing. Earnest money is typically held jointly by the seller and buyer in a trust or escrow account.

Also known as a Good Faith Money.

BREAKING DOWN 'Earnest Money'

When a buyer decides to purchase a home from a seller, both parties enter into a contract stipulating the final sale price of the house and the down payment. The contract does not obligate the buyer to purchase the home since reports from the home appraisal and inspection may reveal problems with the house. The contract does ensure that the seller takes the house off the market while the house is inspected and appraised. To prove to the seller that the buyer’s offer to purchase a property is earnest or in good faith, the buyer will be required to make an earnest payment as a deposit.

The earnest money paid is put toward the buyer's down payment when the transaction is finalized. The transaction is usually finalized after inspections are done and the buyer secures a mortgage with the bank. If the deal falls through, the buyer may or may not be able to reclaim his or her earnest money, depending on how the contract is phrased. If the contract stipulates that the buyer must have appraised the home by a certain deadline, and this does not happen within the specified timeframe, the buyer will probably not be refunded his earnest money. If the buyer decides not to go through with the house purchase for contingencies not listed in the contract agreement, he is most likely to lose the earnest money deposited. The earnest money is retained by the seller to protect the seller from any monetary damages incurred from the broken contract and to keep the resolution of damages out of court. The buyer is likely to get his full earnest deposit back if a failed contingency, such as poor results from an inspection, ensues. Also, if the seller terminates the deal, the earnest money will be returned to the buyer.

The amount of earnest money to be paid varies from city to city and is to be paid within 1 to 3 days after the seller accepts the buyer’s offer. In Seattle, for example, the earnest money deposit lies in the range of 1% to 3% of the sale price of the property. This means that a property selling for $400,000 will require an earnest deposit between $4,000 and $12,000, as negotiated between the buyer and seller. In addition to the local market rates, the amount of earnest money also depends on the level of interest other buyers have expressed, how hot the housing market in the area is, and how quickly a prospective buyer can close on his or her offering price. Some sellers set fixed amounts on earnest money instead of going with a percentage of sale price or down payment. The fixed amount set by sellers usually fall within the range of $5,000 to $10,000. Of course, the higher the earnest money, the more serious the seller is likely to consider the buyer. Therefore, a buyer should ensure to offer a high enough earnest deposit to be accepted, but not too high as to put extra money at risk since there is still a chance that the deal might not go through and the deposit not refunded.

Earnest money is usually paid by certified check, personal check, or a wire transfer into a trust or escrow account which is held by a real estate brokerage, legal firm, or title company. The funds will be held in the account until the sale of the home has been finalized. At this point, the earnest funds are applied towards the buyer’s down payment. It is important to note that escrow accounts, like any other bank account, can earn interest. Therefore, if the earnest funds in the escrow account earn interest of more than $5,000, the buyer will have to fill out tax form W-9 with the IRS to receive the interest.

RELATED TERMS
  1. Retract

    The withdrawal of a bid, offer or statement before any relevant ...
  2. Good Faith Money

    The deposit of money into an account by a buyer to show that ...
  3. Buyer's Market

    A situation in which supply exceeds demand, giving purchasers ...
  4. Settlement Agent

    1. The party involved in completing a transaction between a buyer ...
  5. Soft Market

    A market that has more potential sellers than buyers. A soft ...
  6. Owner Financing

    When a property buyer finances the purchase directly through ...
Related Articles
  1. Investing

    What is Earnest Money?

    An earnest money deposit shows the seller that a buyer is serious about purchasing a property.
  2. Investing

    Contingency Clauses In Home Purchase Contracts

    Here, we introduce widely used contingency clauses in home purchase contracts and how they can benefit both Buyers and Sellers.
  3. Investing

    The Ins And Outs of Seller-Financed Real Estate Deals

    There's more than one way to buy or sell a house. Seller financing presents yet another unique option.
  4. Investing

    Housing Deals That Fall Through

    Find why buyers back out and what you can do if you're left holding the bag.
  5. Investing

    Ins And Outs Of Seller-Financed Real Estate Deals

    Seller financing works like this: Instead of a buyer receiving a loan from a bank, the person selling the house lends the buyer the money for the purchase.
  6. Investing

    12 Steps to Closing a Real Estate Deal

    A long list of things needs to happen before a home becomes yours. Find out what to expect.
  7. Investing

    Understanding The Escrow Process

    Learn the 10 steps that lead up to closing the deal on your new home and taking possession.
  8. Investing

    What You Should Know About Home Sale Contingencies

    A home sale contingency protects buyers who want to sell one home before purchasing another.
  9. Investing

    The Pros and Cons of Owner Financing

    Details on the upside and risks of this type of deal for both the owner and the buyer.
  10. Managing Wealth

    Rent-to-Own Homes: How the Process Works

    Here's what to watch for when negotiating a contract for a rent-to-own home – and who is a good candidate for this option.
RELATED FAQS
  1. What's the difference between a letter of credit and a bank guarantee?

    Learn how letters of credit and bank guarantees differ, how they are used by banks and companies, and how buyers apply to ... Read Answer >>
  2. What are the Differences Between Ex Works (EXW) and Free On Board (FOB)?

    Ex Works describes the situation where the seller is responsible for having her goods ready at her place of business. Free ... Read Answer >>
  3. What are the legal regulations on delivery duty paid?

    Understand the legal requirements for delivery duty paid, as well as how responsibilities can shift between buyers and sellers ... Read Answer >>
  4. If everyone is selling in a bear market, does your broker have to buy your shares ...

    A broker won't lose money when a stock goes down because he or she is usually nothing more than an agent acting on sellers' ... Read Answer >>
  5. What does the variance between the bid and ask price of a stock mean?

    Find out how stocks are traded in the market, why the bid and ask prices are different and why the bid-ask spread is smallest ... Read Answer >>
Hot Definitions
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  2. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  3. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  4. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  5. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  6. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
Trading Center