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Earnest Money: What Is It and How Is It Used to Buy a Home?

what is earnest moneyIf you're shopping for a home today, you may have noticed a lot of other people looking at homes during your house hunt. That's because the housing market is very hot right now! A busy housing market means sellers may likely receive several offers on the same day and have to decide which one to accept. Some sellers will take the highest offer, but others may be swayed by a buyer who pays earnest money.

Don't know what earnest money is? That's what we're here to explain! Here are the basics.

What is earnest money?

Earnest money is a cash offer to the seller, a kind of deposit. For example, if you're looking at a $185,000 house but know that the seller is getting other offers, you can offer to pay $3,000 in earnest money. If the seller approves your offer, that $3,000 is held in trust with the listing agent and at closing gets applied towards your down payment or closing costs. Earnest money shows that you can save money and that you’re serious about buying that house. Earnest money is very common. In fact, 99.9% of real estate deals include it.

The listing realtor will hold on to the earnest money until the deal is approved or canceled. However, earnest money is generally nonrefundable. If you cancel the deal, the only way your money will be fully refunded is if an agreed-upon contingency was written in the agreement.

What should be included in the contingencies?

When you’re confident that you found the right house for your family, there is little risk in offering earnest money. However, to be safe, it’s best to write the following contingencies into the purchase agreement:

Securing financing for the purchase

If a bank is not willing to loan you the money and your application for a mortgage is denied, your earnest money will be refunded if you include a financing contingency in your purchase agreement.

Home inspection results

If issues are discovered during the home inspection that make you want to reconsider the deal, your earnest money will be refunded. A buyer typically has 10 days to complete the inspection and back out of the purchase. Of course, the seller may be willing to fix the problems or renegotiate the purchase price. Either way, you can decide whether or not to move forward.

Sale of your current home

If your current home has not sold by the time of closing on the new property, you can back out of the deal and your earnest money will be refunded. Some sellers may not agree to this contingency because of fluctuations in the real estate market.

Your realtor can tell you what local practice is for earnest money, but it typically ranges from a couple of hundred dollars to a couple of thousand dollars. If the market is aggressive, expect the earnest money to be higher.

An experienced realtor can write a solid contract that protects you and your earnest money. Together, with the deposit, this shows the seller that you are a determined buyer.

first time homebuyer guide