How Earnest Money Works

 In First-Time Home Buyers

Many people are confused about the earnest money deposit check they have to write when making an offer on a house. Is it part of the down payment? Is it part of the closing costs? Can I get it back if I decide not to purchase the house?

Here’s what you need to know.

What is Earnest Money For?

When a buyer makes an offer on a house, they are typically required to write a check to the holder (usually the title company) for a small amount of the purchase price.  The purpose of the earnest money is to show the seller that the buyer is serious about making the offer.

How much is it?

The amount is negotiable between the buyer and seller, but it’s usually about 1% of the offer price.  As an example, if the offer is for $400,000, the earnest money will usually be about $4,000. Again, the amount is negotiable, so don’t assume it will always be 1% of the offer price.

Is it a part of the down payment or the closing costs?

Earnest money is a part of the down payment.  If someone is buying a house for $400,000 and the down payment required by the lender is 5% of the purchase price, the down payment would be $20,000. That amount is due at the closing. However, if they have already written an earnest money check for $4,000, then the balance of the down payment due at closing would only be $16,000.  The earnest money is subtracted from the down payment (20,000 – 4,000 = 16,000).

Again, the earnest money is a part of the down payment. It is not part of the closing costs. Closing costs (lender fees, title fees, appraisal fee, etc.) are in addition to the down payment, and the earnest money has nothing to do with the closing costs.

Can I get that money back?

If a buyer decides they do not want to purchase a house after paying the earnest money, they are entitled to get that money back, but only if they abide by the provisions stated in the sales contract they signed with the seller.  

No one really wants to talk about a deal falling apart before they have even made an offer on a house, but it is extremely important for a buyer (and a seller) to discuss the contract provisions with their real estate agents before signing the contract. Although we, as lenders, see and read many more contracts (both good ones and bad ones) than most real estate agents do, we are not licensed as real estate agents, so we are unable to give advice regarding earnest money or any other part of the contract.

The bottom line regarding earnest money is this:

  • It is money a buyer pays when they make an offer on a house to show the seller they are serious about their offer
  • The amount is negotiable
  • The money is subtracted from the down payment amount
  • It has nothing to do with the closing costs

If still have questions, contact us. We are more than happy to help.

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