Definition:
An earnest money deposit is a sum of money a buyer pays upfront to show they are serious about purchasing a home. It’s held in escrow and later applied to the purchase price or returned under certain conditions.
Example:
Jessica makes an offer on a $350,000 home and includes a $5,000 earnest money deposit. This money is held by the title company. If the sale goes through, it’s applied toward her closing costs. If she backs out without a valid reason, the seller may keep the deposit.
Explanation:
In real estate, the earnest money deposit shows the seller that the buyer is committed to the deal. It acts as a financial “good faith” gesture to help secure the contract. The amount typically ranges from 1% to 3% of the purchase price, though it can be more in competitive markets.
The deposit is usually submitted after the seller accepts the buyer’s offer and is held in a neutral escrow account until closing. If the transaction goes as planned, the earnest money is applied toward the buyer’s down payment or closing costs.
However, if the buyer backs out of the contract for a reason not covered by a contingency—such as changing their mind—the seller may be entitled to keep the deposit. If the buyer exits the deal for a valid reason (like a failed inspection or financing issue covered by a contingency), the deposit is typically refunded.
Why is Earnest Money Deposit Important in Real Estate Transactions?
The earnest money deposit protects both buyers and sellers. For sellers, it reduces the risk of taking a property off the market only for the buyer to walk away. For buyers, it strengthens their offer and shows commitment. Understanding how earnest money works ensures smoother negotiations and helps both parties feel more secure in the transaction.