On the first page of an offer, one of the terms you’ll decide on as a buyer is the amount of earnest money you’ll deposit. Every first-time buyer I work with asks all about earnest money – what it’s for, where it goes, how much it should be, and other questions. Every time I help clients write an offer, no matter how many times they’ve bought and sold in the past, we discuss the earnest money. Let me explain it here…
Earnest money is a deposit to show a seller that you intend “in earnest” to buy the property — to close the sale. In my experience the earnest money is always in the form of a check, but it could be anything. It could be a piece of jewelry or any “widget of acceptable (to the seller) value.”
The check is written out to the escrow company handling the transaction. They cash it and deposit it in a trust account. It’s still your money — the buyer’s money — and if the transaction goes all the way to closing, the full amount of the earnest money is credited to your down payment and closing costs.
How much is it? In my experience, it’s usually between 0.5% and 1% of the purchase price. It’s one of many ”terms” in the offer that the seller can accept as-is or counter. I’ve seen earnest money checks for 10% of purchase price, mean to “Wow!” a seller into accepting an offer. That particular earnest money was also made non-refundable UPON ACCEPTANCE of the offer! (Yes, that buyer got the house.)
The seller sees the earnest money as a “score” of how seriously you, the buyer, are going to take the transaction, the deadlines, and the requirements you must meet. Most sellers figure that a buyer could very likely walk away from $500 (a low score), but wouldn’t very likely walk away from $10,000 (a great score!)
As long as you, the buyer, meets your deadlines such as:
1) applying for financing and home owner’s insurance within 5 days of mutual acceptance;
2) having the home inspection done and your response in by the inspection deadline that you’ve set;
3) completing your feasibility study (typically on land) by the deadline you’ve set, etc;
…then you keep your earnest money safe from forfeiture to the seller if you do need to rescind the offer. If you get sloppy, miss your deadline, and expect your earnest money back in full… well, you might have a rude awakening.
This is just a basic overview of earnest money. Like most terms in a real estate transaction, it is highly variable. It can change in the midst of a transaction. It can be split between parties and even their agents in certain situations. Some people talk about doing away with it altogether, but personally I like it. It gets you, the buyer, vested in the property and the process. It gets you committed, and all sorts of good things happen when one is committed.
