When you go under contract to purchase a home, one of the next steps is to make the “earnest” or “escrow” deposit.

What is Earnest Money?

Earnest money, also known as a good faith deposit, is a sum of money provided by the buyer as a demonstration of their commitment to the purchase of a property. It is typically presented when making an offer on a home and held in escrow until the transaction is closed. The purpose of earnest money is to assure the seller that the buyer is serious about the purchase and to compensate the seller if the buyer fails to fulfill their contractual obligations.

Purpose and Benefits

Displaying commitment: By offering earnest money, homebuyers demonstrate their seriousness about the transaction, showing sellers that they are motivated and willing to proceed with the purchase.

Securing the property: Earnest money can give the buyer a competitive edge in a competitive market. Sellers are more likely to consider offers with earnest money, as it reduces the risk of the buyer backing out of the deal.

Creating a binding contract: Once an offer is accepted and earnest money is deposited, a legally binding contract is established between the buyer and seller. This provides a foundation for the transaction and outlines the rights and responsibilities of both parties.

Compensation for the seller: In the event that the buyer fails to meet the obligations outlined in the contract, such as withdrawing from the purchase without a valid reason, the seller may be entitled to keep the earnest money as compensation for any damages or expenses incurred.

Amount and Payment

The amount of earnest money varies depending on factors such as the local market, the property’s value, and the buyer’s financial capabilities. Typically, it ranges from 1% to 5% of the purchase price, but it can be negotiated between the parties involved. The earnest money is typically paid through a personal check, cashier’s check, or wire transfer to the designated escrow or title company.

Escrow and Disposition of Funds

Upon receipt, the earnest money is held in an escrow account, which is a neutral third-party account managed by an escrow or title company. The funds remain in escrow until the transaction is finalized or until both parties agree to release them earlier under specific circumstances, such as contingencies that render the contract void.

If the transaction proceeds as planned, the earnest money is typically credited towards the buyer’s down payment or closing costs. However, if the buyer breaches the contract without a valid reason, the earnest money may be forfeited to the seller as compensation for their losses. In some cases, disputes over the disposition of the earnest money can arise, and mediation or legal action may be necessary to resolve them.