You’re here because you’re wondering what is earnest money when buying a house. This is a common question, I get it all the time.
Earnest money is a deposit that provides security for the seller in the event the buyer backs out of the deal.
By it’s very name, earnest, it means intense conviction. It’s good faith. The buyer fully intends on buying the home and not just there to waste the seller’s time.
Is Earnest Money Required?
Legally, no. Traditionally and expected, yes.
While there are no laws or regulations that require a buyer to pay earnest money when purchasing a home, it sure is expected by sellers.
In fact, you’d be hard-pressed to find a seller that would accept an offer that does not include earnest money.
How Much Earnest Money Should I Put Down?
This is where you can get creative. As mentioned before, there’s no requirement for earnest money, same goes for the amount a buyer offers.
Typically earnest money is between 1% and 3% of the total purchase price of the home.
In other words, if you’re purchasing a $300,000 home, your earnest money will be between $3,000 and $9,000. It doesn’t have to necessarily be tied to a percentage, that’s just a starting point. A buyer’s earnest money could be a random dollar amount as well, say $2,500.
Keep in mind, it shows the seller that you mean business, or earnest. You’re either very interested in their home and going to follow through until closing, or you’re on the fence and could back out.
The more earnest money you put down, as well as other factors, could convince a seller to go with your offer.
Think of it this way, a seller receives two identical offers for the asking price for their home at $300,000. Both offers want home warranties, both have the same closing dates, you get the idea. However, one offer includes 1% ($3,000) earnest money, the other is 1.5% ($4,500). Which one is more appealing to the seller?
Seems clear enough, the second offer is. The seller thinks that buyer is more serious about purchasing the home.
Real estate is all about negotiating. Not negotiating in the sense you’re purchasing a car and the salesman is asking how much you owe on your trade-in, but instead negotiating through Realtors using a contract.
The earnest money when buying a house can be a pivotal factor in the contract that convinces the seller to go with your offer.
When is Earnest Money Due?
Here in Texas, you have 3 business days after the execution of the contract to deliver the earnest money to the seller.
Notice I said business days. If the deadline for earnest money lands on a weekend or legally-recognized holiday (sorry Festivus, you don’t count – Seinfield fans will understand that joke), then the earnest money is due the next business day.
So, for example, you put an offer on a house on Saturday. The seller mulls it over and finally agrees to your terms and accepts the contract on Sunday. The contract is now effective. On the third day following the contract effective date the earnest money is due by the end of the day.
Here’s another example.
This time the contract is executed on Wednesday. Three days later, when the earnest money is typically due, falls on a Saturday. The following day is Sunday and that Monday is a holiday. Since the due date cannot fall on a weekend or holiday, the earnest money is due on Tuesday.
Alright, last example.
The contract is executed on Thursday. The third day is a Sunday and therefore the earnest money is due on Monday. The weekends still count towards the three days, it’s just that the actual due date cannot be on a weekend or holiday.
Does Earnest Money Go Towards Down Payment?
It can, but not necessarily.
When a buyer pays their earnest money to the seller, the money is either held in an escrow account. The money will reside in this account until closing.
At closing you may have one of several options with the earnest money.
You can choose to apply it to any closing costs you have, apply it as part of a down payment, or have it returned to you.
For example, if you’re purchasing a home using a VA loan, you probably don’t have many – if any – closing costs at all and you’re probably not putting any money down. So in this example you could walk away with your earnest money to do as you please.
Bottom line, it’s not the seller’s money to keep. In fact, the seller never actually receives the earnest money, the escrow account is usually managed by the title company, the seller’s real estate agent, or some other third party. This is what keeps anything shady from happening with your earnest money.
When Can the Seller Keep Earnest Money?
If the buyer follows through with their contract to purchase and closes on the home, or they exercise their option as written in the contract, then the seller does not keep the earnest money.
However, there are some instances in which the seller can keep the money.
It all depends on how the One to Four Family Residential Contract (Resale) is written.
These situations are generally when the buyer backs out of the contract, for whatever reasons, and does not have a contingency in the contract. This is a breach of the contract and the seller gets to keep the earnest money.
Earnest Money and Contingencies
Contingencies are often written into contracts to protect the buyer. They essentially give the buyer a way out of a contract for various reasons and allow the buyer to keep their earnest money.
For example, a contract is executed with a contingency that the buyer’s financing must be approved. This is very common.
In this case, if the lender comes back to the buyer and says that they cannot be financed, the buyer can’t purchase the home. They don’t have the financing and therefore have to back out of the contract. The buyer will get their earnest money back because they had this contingency written into their contract.
If they didn’t have this contingency clearly laid out in their contract, then they would forfeit their earnest money to the seller.
Earnest Money and Buyer’s Remorse
Another reason for a buyer to back out of a contract is simply because they want to. Some may refer to this as cold feet or buyer’s remorse, whatever the case, the buyer has a change of heart and doesn’t want the home.
Of course this comes with it’s own set of problems, one of them is that the earnest money is kept by the seller.
Remember, the earnest money shows good faith to the seller that you intend to purchase the house, but now you changed your mind. That earnest money is the cost of being undecided.
By now you should have a clear understanding of earnest money when buying a house. Just remember, it’s all about good faith. As long as you intend to purchase the home, it will always be your money.
If you have any questions, don’t hesitate to ask me. Give me a call or shoot me an email and we can discuss earnest money a little more in depth.