Earnest money: What is it and how much is enough?

Buying a home can be a lengthy process for both the buyer and seller. The last thing a seller wants is to accept an offer from someone who wants to buy their house, only for the buyer to walk away from the deal weeks later, leaving them to start the process of finding a buyer again.

This is why most buyers offer earnest money when they make an offer to buy a house. It signals to the seller that they are serious about buying the house.

Buyers who want to make their offer even more appealing to sellers can also consider a Verified Approval Letter (VAL)¹ from Rocket Mortgage.

What is earnest money in real estate?

Earnest money, also called a good faith deposit, is an upfront payment that goes toward the home’s eventual sale price and shows the seller that the buyer is serious about completing the purchase. When you make an offer to buy a home, you’ll typically provide an amount of earnest money with the offer.

If the seller accepts your offer, your earnest money typically gets deposited into an escrow account. If you back out of the deal for a reason that isn’t covered by a contingency in your offer, the seller gets to keep the earnest money. If the sale is completed, the earnest money is put toward the purchase price of the home.

How much do you need to pay in earnest money?

Earnest money is typically around 1% – 3% of the sale price and is held in an escrow account until the deal is complete. The exact amount depends on what's customary in your market.

For example, if your area has very low housing inventory, larger amounts of earnest money may be more common than smaller amounts. Offering closer to 3% can even help you win your bid because it shows sellers that you have the money to close the deal. Most buyers do not have the resources to buy a house with cash, but it’s still important to present a strong offer to the seller.

What happens to earnest money at closing?

When a seller accepts your offer to buy a home, the earnest money you supply gets put into an escrow account.

If the closing process goes smoothly, the earnest money gets disbursed from escrow and is applied toward the purchase price of the home, usually as part of the down payment or closing costs.

If the process does not go smoothly, for instance due to a failed home inspection, what happens depends on the details of your offer to buy the home. If you included contingencies, legal requirements that the seller or the home must meet for the sale to complete, you may be able to back out of the purchase and get your earnest money back.

Buyers who back out of a deal for a reason not covered by a contingency included in their offer will lose both the home and their earnest money.

When is earnest money refundable?

Earnest money is refundable depending on the terms of your contract. This is why you should always include contingencies, which are conditions that must be met for the process to move forward. If one of the contingencies included in your offer is not met, you can walk away and get your earnest money back.

These are some of the most common contingencies that people include in offers to buy a home.

Home inspection contingency

A home inspection contingency lets the buyer hire a home inspector to examine the property. If the inspector finds major defects or necessary repairs that would cost more than a set amount, the buyer could back out of the deal.

For example, you might have a contingency that if mold is found in the home, you have the right to back out. Or, if foundation issues are found, they must not exceed a certain amount to repair. The point is, contingencies give you the chance to back out with your earnest money or negotiate the deal further with the seller.

Appraisal contingency

As part of the underwriting process, mortgage lenders send a professional appraiser to inspect a home and determine a fair value for it. If a home does not appraise for a sufficient value, the lender may not approve the loan because the home won’t serve as sufficient collateral.

If you include an appraisal contingency, you may be able to back out and get your money back if the appraisal comes in below value.

Financing contingency

Most people get a mortgage to buy a home because they can’t afford to pay hundreds of thousands of dollars upfront. For this reason, a financing contingency is essential in almost any offer to buy a home.

If you make reasonable efforts to qualify for a loan but find yourself denied, a financing contingency lets you back out of the deal and get your earnest money back. Without this contingency, failing to qualify for a loan would see you losing your earnest money and possibly other consequences, depending on the contract.

Contingency for selling an existing home

If you already own a home and are moving, you may include a contingency that you won’t complete the purchase until you sell your existing home. This is especially common if you’re planning to use proceeds from the sale of your previous home to fund the purchase of the new one.

With this contingency, you can recover your earnest money if you’re not able to sell your old home and can’t fund the new purchase. The seller might continue to show the home while you’re trying to sell your home, letting prospective buyers know about the situation by listing it as “active contingency.” This way, if you don’t come through, the seller hasn’t wasted all the time waiting.

Should you waive a contingency?

Most home buyers should never waive a contingency, because the risks involved are serious. For example, if you waive a home inspection contingency, you could wind up buying a home that needs tens or hundreds of thousands of dollars in repairs.

It might be tempting to waive contingencies in a competitive real estate market, but you should consider the risks and get advice from a real estate and/or legal expert before doing so.

Tips to protect your earnest deposit

Providing earnest money means taking a risk, so it’s important to take steps to protect your deposit, especially in competitive markets where you’re likely offering a larger amount.

1. Use an escrow account

The most important thing to do to protect your earnest money is to use an escrow account. An escrow account is held and controlled by a third party rather than you or the home seller.

This ensures the seller doesn’t try to walk away with your money. It also protects the seller because you’ve already handed over the deposit and can’t get it back without good reason, such as a failed contingency.

2. Know your contingencies

Whenever you’re trying to buy a home, it’s important to work with an experienced real estate professional. They can help you draft your offer to purchase a property and give you information about the contingencies you should include.

Make sure you know what contingencies you’ve included, such as a financing contingency or inspection contingency, and the conditions that will let you get your earnest money back.

3. Stay on track with your responsibilities

Making an offer to buy a home is an early step in the home buying process. It can take weeks from the time your offer is accepted to the time you close on the home, and you have a lot to do during that time, such as scheduling an inspection, finishing your loan application, sending documents to the right places, and so on.

If you don’t keep up your end of the deal, the seller may cancel the sale and keep your earnest deposit, depending on the terms of the contract. So be sure to keep close track of what you need to do and when it needs to be done to keep the process moving forward.

4. Put everything in writing

With any major financial transaction, it’s important to have everything in writing so that both parties can plainly see the details of the earnest money deposit and the sale process.

There are many common real estate scams, so proper documentation of any conversations and agreements can help keep all the parties protected.

Earnest money in practice

These examples will provide a good illustration of how earnest money works and why it can be helpful for home buyers to offer an earnest deposit.

Situation A: The forfeited deposit

Alex, Taylor, and Sam are all selling their homes. Charlie is a home buyer who has looked at all three houses and wants one of them but can't quite decide which one.

Charlie doesn't want to decide on a single house just yet and makes a good-faith deposit on all three houses. Alex, Taylor, and Sam each take their homes off the market and inform their other potential buyers that Charlie wants the house.

Later, Charlie decides to buy Alex’s house. Taylor and Sam now must put their homes back on the market and start looking for buyers all over again. Luckily, Charlie’s earnest deposits are Taylor’s and Sam’s to keep. This offers them some compensation for the time and money they lost due to Charlie backing out of the sales.

Situation B: The contingency option

Charlie makes a single deposit to Alex but discovers the house is infested with cockroaches after a professional home inspection. Luckily, Charlie has a home inspection contingency in the purchase agreement and decides not to buy. Because of this contingency, Charlie gets the earnest money deposit back from Alex. Charlie is then able to make an offer on Sam’s house with the money.

Situation C: The failed offer

Charlie makes an offer to buy Sam’s house in a competitive market and makes an earnest money deposit. Once they accept the offer, Sam turns down competitive offers from other buyers. To secure an offer, Charlie offered to waive any contingencies when making their offer. Unfortunately, a sudden financial downturn causes the housing market to cool, and Charlie loses their job.

The job loss means that Charlie is unable to get final approval for a mortgage and withdraws the offer. Because there were no contingencies in place, Charlie is required to forfeit their earnest money deposit.

While this is unfortunate for both parties, Sam can keep the earnest money to help cover the potential losses from not being able to sell their house sooner. Charlie is also protected against potentially being sued for breach of contract.

FAQ

Before you buy a home, make sure you understand earnest money. These questions and answers can help.

Who keeps earnest money at closing?

When you close on a home, the earnest money you offered is applied to the purchase price of the home. For example, if you gave a deposit of $5,000 and need to make a $10,000 down payment, you’d only provide $5,000 at closing, using the earnest money to cover the rest of the down payment.

Can I back out after giving earnest money?

Yes, you can back out of a home purchase at any time, including after giving earnest money. However, if you don’t have a good reason for doing so, you may have to forfeit the earnest deposit.

Can I get my earnest money back if my loan is denied?

You may be able to get your earnest money back if you fail to qualify for a loan, depending on the terms of your contract. If you included a financing contingency in your offer to buy the home, you’ll be able to get the money back. Without a financing contingency, the seller can keep the deposit.

The bottom line: A decent amount of earnest money can make a difference

Think of earnest money as a deposit you’re putting down on a home with your offer to buy it. If the sale closes, your earnest money will go toward the down payment or the closing costs. If you pull out of the deal and your reason is not covered by a previously agreed-upon contingency, you could lose your earnest money. The seller keeps it to compensate them for time lost. This is why it’s important to have contingencies in your purchase agreement.

At the same time, a healthy amount of earnest money with your offer shows a seller you are serious about buying the home. This can make your offer more competitive.

If you’re ready to buy a home, you can get preapproved for a loan through Rocket Mortgage.

¹ Participation in the Verified Approval program is based on an underwriter’s comprehensive analysis of your credit, income, employment status, assets and debt. If new information materially changes the underwriting decision resulting in a denial of your credit request, if the loan fails to close for a reason outside of Rocket Mortgage’s control, including, but not limited to satisfactory insurance, appraisal and title report/search, or if you no longer want to proceed with the loan, your participation in the program will be discontinued. If your eligibility in the program does not change and your mortgage loan does not close due to a Rocket Mortgage error, you will receive the $1,000. This offer does not apply to new purchase loans submitted to Rocket Mortgage through a mortgage broker. Rocket Mortgage reserves the right to cancel this offer at any time. Acceptance of this offer constitutes the acceptance of these terms and conditions, which are subject to change at the sole discretion of Rocket Mortgage. Additional conditions or exclusions may apply.