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What is an Earnest Money Deposit When Buying a Home?

May 03, 2023
Living room in Cira Plan 2 at The Landing by Brookfield Residential in Tustin CA

When you’re interested in purchasing a particular house, putting in an earnest money deposit may help improve your chances of securing the deal. You may be asked to commit to an earnest money deposit as part of your offer to purchase a home or to deliver it when you sign the sales contract or purchase agreement.

Here, we explain answers to questions like:

  • What is an earnest money deposit?
  • What is earnest money when you’re buying a house?
  • What is earnest money used for?

Learn how offering an earnest money deposit may benefit you and what to consider before providing one.

What Is Earnest Money Used For?

In sales transactions, earnest money represents a buyer’s good faith and intention to fully carry out a purchase. It’s an upfront deposit that’s offered when there are potentially many buyers interested in purchasing the same product, service, or property.

What is earnest money when you’re buying a home? An earnest money deposit is a payment a homebuyer makes to a seller to show they’re serious and committed to purchasing a home. It typically amounts to between 1% and 5% of the sales price or sometimes higher.

A prospective homebuyer offers an earnest money deposit before the house closing is complete. An earnest money deposit reassures sellers that, barring a problem like a home inspection issue or a low appraisal, the buyer is committed to purchasing their home, and the sale will go through. It can also motivate a seller to take their home off the market and proceed selling to the homebuyer who offered the deposit.

Who Keeps Earnest Money?

Is an earnest money deposit refundable? Who keeps earnest money depends on the home inspection, other contingencies, or both as listed in the purchase agreement.

If the sale proceeds as expected, the earnest money deposit will be applied to the homebuyer’s down payment or closing costs. If, however, you discover problems during a home inspection or some other events affect the contract terms, your earnest money deposit may be refunded.

In some situations, a home seller may be able to keep the earnest money deposit. For example, a homebuyer puts an earnest money deposit on several homes they’re interested in to have more time to consider their choices; their earnest money deposit funds will only apply to the home they choose.

On homes they decide not to buy, prospective buyers will have to forfeit the earnest money deposit because sellers have to go through the trouble of putting their home back on the market. The earnest money deposit in those cases is intended to help compensate the sellers for lost time and delays in the selling process.

What Is the Difference Between Escrow and Earnest Money?

Escrow and earnest money are separate components in the home loan process. Escrow refers to a third-party holding money or an asset on behalf of two parties finalizing a transaction. This intermediary party, which may be an escrow company, keeps the funds safe and secure until the seller gets paid after the contractual requirements are met. Escrow also helps ensure the homebuyer isn’t susceptible to fraud or loses their deposit based on factors outside of contractual terms.

Escrow is typically associated with the final stages of purchasing a home, when a homebuyer pays the final amount to complete the sales transaction. Escrow can also be used to manage an earnest money deposit earlier in the homebuying process.

If your earnest money is in escrow, but you discover problems that make you want to back out of the home purchase, you may be able to recover your earnest money deposit, depending on the terms of the contract. If you have earnest money in escrow but fail to fulfill your contract obligations, the seller may be able to keep the earnest money deposit.

If the seller chooses you as the homebuyer, the earnest money deposit may be applied toward other costs.

Should You Make an Earnest Money Deposit?

In a competitive housing market where everything from interest rates and mortgage terms to home financing and budgets can impact your search and housing availability, offering an earnest money deposit can give you an advantage as a homebuyer. It shows the seller you’re serious enough to commit funds to the transaction early in the homebuying process. It can provide peace of mind for the seller and eliminate your competition as you work on finalizing a home purchase.

If you’re serious about a home, offering an earnest money deposit can only help you. If there’s something wrong with the house and you have inspection and appraisal terms in the contract, your deposit is protected and can be refunded. If you end up with the home, you don’t lose any money or have to spend extra, as the deposit applies to what you’re already paying.

It’s essential to outline all earnest money deposit terms in a written contract to eliminate misunderstandings and ensure the seller and homebuyer agree on the deposit.

Looking for a New Home?

At Brookfield Residential, our expert team can help you navigate the homebuying process, from helping you understand how much home you can afford to helping you get preapproved for a mortgage.

Check out our blog for more homebuying resources, and explore our communities, where we build new construction homes all across North America.