Earnest Money

Earnest Money Definition

Earnest money is a deposit made by a buyer to a seller to demonstrate the buyer’s good faith in completing a real estate transaction. This deposit secures the agreement and is often a prerequisite when a buyer signs a real estate purchase contract. The earnest money is typically held in escrow or a separate account by a third party until the purchase is finalized.

Examples

Example 1

A buyer is interested in purchasing a house listed for $300,000. To show their commitment to the seller, the buyer deposits $10,000 as earnest money. This amount is later applied towards the down payment and/or closing costs upon successful completion of the sale.

Example 2

During the real estate transaction, the buyer provides earnest money that is held by their real estate broker in a trust account. If the sale closes successfully, this earnest money goes toward the final purchase price of the property. If the deal falls through due to the buyer’s fault, the seller may have the right to keep the earnest money as compensation for lost time and opportunities.

Frequently Asked Questions (FAQ)

What is the Purpose of Earnest Money?

Earnest money helps to signify a buyer’s genuine interest in a property. It signals seriousness and good faith toward completing the purchase.

How Much Earnest Money is Required?

The amount varies widely based on market conditions and negotiated terms. Typically, it ranges from 1% to 5% of the home’s purchase price.

What Happens to the Earnest Money if the Sale Falls Through?

If the deal falls through due to issues with financing, contingencies, or seller default, the earnest money is usually refunded to the buyer. If the buyer backs out without valid reasons or breaches the contract, the seller may keep the earnest money.

Who Holds the Earnest Money?

Earnest money is typically held in an escrow account managed by a third party, such as a real estate broker, title company, or escrow company, until the sale is finalized.

Is Earnest Money Refundable?

Earnest money may be refundable depending on the terms of the real estate contract, especially if specific contingencies, such as inspections or financing terms, are not met.

Sales Contract

A legal document that outlines the terms and conditions of a property sale between a buyer and seller. It often mentions the earnest money deposit.

Down Payment

A portion of the purchase price that the buyer pays upfront in addition to their loan or mortgage.

Closing

The final step in executing a real estate transaction where the title is transferred from the seller to the buyer and all contractual obligations are met.

Escrow

A third-party account where funds are held temporarily during the transaction process to ensure secure transfer and protection of both parties’ interests.

Commingling

The unlawful practice of mixing personal funds with clients’ funds, which is prohibited in real estate transactions.

Online Resources

References

“The Complete Guide to Financing Real Estate Developments” by Jack Cummings
“Real Estate Investing For Dummies” by Eric Tyson and Robert S. Griswold

Suggested Books for Further Studies

“The Book on Rental Property Investing: How to Create Wealth With Intelligent Buy and Hold Real Estate Investing” by Brandon Turner
“Real Estate Principles: A Value Approach” by David C. Ling and Wayne R. Archer
“Real Estate Finance & Investments Risks and Opportunities” by Peter Linneman

Real Estate Basics: Earnest Money Fundamentals Quiz

### What is earnest money? - [ ] A bonus given to real estate agents. - [x] A deposit made by a purchaser to show good faith in a transaction. - [ ] The final payment in a property sale. - [ ] A tax levied on property purchases. > **Explanation:** Earnest money is a deposit made by a buyer to show good faith in a real estate transaction and secure the agreement. ### Where is earnest money typically held until the deal closes? - [ ] In the seller's personal account. - [ ] In the buyer's savings account. - [x] In an escrow account held by a third party. - [ ] Under the buyer's primary residence. > **Explanation:** Earnest money is typically held in an escrow account managed by a third party such as a real estate broker or title company until the property transaction is finalized. ### What happens to the earnest money if the buyer backs out of the deal without a valid reason? - [ ] It is refunded to the buyer. - [x] It is kept by the seller. - [ ] It is given to the real estate agent. - [ ] It remains in escrow indefinitely. > **Explanation:** If the buyer backs out of the deal without a valid reason, the seller usually keeps the earnest money as compensation. ### What percentage of the home's purchase price does earnest money often range between? - [ ] 0.5% to 1% - [ ] 10% to 20% - [ ] 6% to 8% - [x] 1% to 5% > **Explanation:** Earnest money generally ranges from 1% to 5% of the home's purchase price, depending on the terms negotiated and market conditions. ### Can earnest money be applied to the down payment? - [x] Yes, it is often credited towards the down payment at closing. - [ ] No, it is a separate fee. - [ ] Only if both parties agree. - [ ] Earnest money cannot be used as part of the down payment. > **Explanation:** The earnest money deposit is often credited towards the buyer's down payment or closing costs upon the successful completion of the sale. ### Is earnest money ever refundable? - [x] Yes, under certain conditions specified in the contract. - [ ] No, it is non-refundable in all cases. - [ ] Refunds occur only if processing delays happen. - [ ] Only at the seller's discretion. > **Explanation:** Earnest money is typically refundable if specific contingencies such as financing, inspections, or seller issues are not met as outlined in the contract. ### Who benefits from holding the earnest money? - [x] Both parties, as it ensures the buyer's intent and secures the seller. - [ ] Only the buyer benefits. - [ ] Only the seller benefits. - [ ] The real estate broker earns interest from the funds. > **Explanation:** Both parties benefit from the earnest money arrangement as it secures the buyer's intention and offers the seller assurance of the buyer's commitment. ### What term is used to describe a mix of personal and client funds? - [ ] Segregation - [x] Commingling - [ ] Bonding - [ ] Pooling > **Explanation:** Commingling refers to the unlawful practice of mixing personal funds with clients' funds, which is strictly prohibited in real estate transactions. ### When is the earnest money typically provided? - [x] At the time of signing the sales contract. - [ ] During the property inspection. - [ ] After the mortgage has been approved. - [ ] At the closing table. > **Explanation:** Earnest money is typically provided at the time of signing the sales contract to signify the buyer's commitment to the transaction. ### What can violate the proper handling of earnest money? - [ ] Holding it in an escrow account. - [ ] Refunding it under contract terms. - [x] Depositing it into the broker's personal account. - [ ] Applying it to closing costs. > **Explanation:** Depositing earnest money into the broker's personal account violates proper handling regulations. It should be held in a separate escrow account.