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To show you are serious about buying a home, “earnest money” is a good-faith deposit you would make. This money is deposited after the seller has accepted your offer and is usually kept in an escrow account. When the sale closes, you can keep the cash or apply the money toward the purchase.
The earnest money you pay when purchasing a home can vary widely. Some home buyers pay as little as $500, while others pay several thousand dollars. The amount is negotiable between you and the sellers. It can depend on various factors, including the price of the home, the strength of the local real estate market, and your financial situation.
As a general rule, the earnest money deposit should be enough to show the seller that you’re indeed very serious about purchasing their house, but it shouldn’t be so large that it puts a strain on your finances. In most cases, earnest money deposits are a small percentage of the home’s purchase price, typically ranging from 1% to 3%.
The purpose of earnest money is to provide the seller with compensation if you were to back out of the deal through no fault of the seller and in violation of the agreements in the purchase contract. If that happens, the seller will keep the earnest money.
However, if you were to back out of the deal because a contingency in your contract was not met, in most cases, you’ll get your earnest money back. Most contracts include four common contingencies that allow you, as the buyer to terminate the agreement and remain entitled to a refund of the earnest money deposit:
- The home inspection contingency: As the buyer you will determine the period to conduct due diligence on the condition of the home, including the home inspection. If the inspection discovers issues that are not acceptable to you, the contract may be terminated and your money will be returned as long as it is within the specified time in the contract.
- The appraisal contingency: Applies to any offer that requires a mortgage to purchase the home. You would decide a date by which the lender conducts an appraisal. If that appraisal comes in below the purchase price in the contract, you would be able to back out and get your money back.
- The financing contingency or mortgage contingency: This is used when the offer will require a mortgage to purchase the home. It’s a time that you would set to secure financing approval from your lender. If the financing should fail, you would be able to get out of the contract and your money would be returned as long as it is within the timeframe you had set in the contract.
- The home sale contingency: You would have the ability to back out of any contract if your current home does not sell in time. As long as you had this included in the contract, you will get your earnest money back.
The Bottom Line: Earnest money exists for two primary reasons: to help a potential buyer strengthen their offer on a new home and to protect the seller from losses if a buyer isn’t able to follow through.