Earnest Money - What You Need To Know

You include earnest money with an offer on a house to show the seller that the you are serious about purchasing the house. It becomes part of the down payment if the offer is accepted, is returned if the offer is rejected, or is forfeited if you pull out of the deal for reasons other than those stipulated in the offer. A financing contingency is an example of the latter - if your offer was contingent on getting a loan, and you can't, you can cancel the contract and get your earnest money deposit back.

How Much Earnest Money?

The size of the earnest money deposit is up to you. Real estate agents will sometimes outright lie, and tell you it is this or that amount, or this or that percentage of the offering price. In reality, you can write the offer with a one dollar deposit if you wish, and agent still has to present the offer.

Naturally, an offer with one dollar of earnest money may not be taken seriously, and the agent may even persuade the seller to reject your offer. It is a good idea to ask what the local norm is. We just bought a house in Colorado, and the agent told us that a $1,000 deposit was normal. Had he said $5,000 was normal, however, I still would have given a deposit of just $1,000. That is enough to be serious in my mind.

You can also do a two-part deposit. You can make an offer with just $100 in earnest money, for example, but specify in the offer that this will be increased to $2,000 once the offer is accepted, or once when an inspection, appraisal or other contingency is met. This keeps your money from being tied up until you know that the seller is serious about selling to you. This will usually still be seen as a serious offer if the deposit is to be seriously increased at some point.

Who Gets The Earnest Money Deposit?

Never give your earnest money check to the seller. The last thing you want is a seller trying to keep your money after you pull out of a deal because of financing problems, termite infestations or other valid contingencies in your offer. If the real estate office handling the sale has an escrow account, it should be safe to make the check out to the broker. Otherwise, use a title company or other escrow account, but in any case, always give your deposit to a third party to hold.

Ask how they handle it too. I once had an offer rejected, and then had to wait a week to get my money back. They told me that they had to wait for my check to clear before they could issue a check back to me. I prefer it when it is handled like it was on our recent home purchase. They just hold the check until the offer is accepted, and return or destroy it if the offer is rejected. 

How To Protect Yourself

Things can happen, right? If you pull out of the deal for some unforeseen reason - one not included in the contract - you'll lose your deposit. However, the seller could also sue you for additional damages or even force you to buy the home. To protect yourself, have a clause in the offer that specifies the earnest money as "liquidated damages" if you are in default. The real estate agent can help with the language, but this basically means that if you need to default on the contract, the seller can't ask for more than what you have already included as earnest money.