When buying a home, earnest money plays a crucial role in showing the seller that you’re serious about the purchase. This good faith deposit is typically submitted along with the offer and held in escrow until closing. But what happens to the earnest money at closing?
In this topic, we’ll explore how earnest money works, what happens to it at closing, and how buyers can protect their deposit throughout the home-buying process.
What Is Earnest Money?
1. Definition of Earnest Money
Earnest money is a deposit made by a homebuyer to show commitment to purchasing a property. It demonstrates serious intent and gives the seller confidence that the buyer won’t back out without cause.
2. How Much Earnest Money Is Required?
The amount of earnest money varies, but it’s typically 1% to 3% of the home’s purchase price. In competitive markets, buyers may offer higher deposits to strengthen their offer.
3. Where Is Earnest Money Held?
Once a seller accepts an offer, the buyer’s earnest money is placed in an escrow account managed by a neutral third party, such as a title company, escrow company, or real estate brokerage.
What Happens to Earnest Money at Closing?
At closing, the earnest money is not lost or forfeited-instead, it’s applied toward the buyer’s expenses. Here’s how it typically gets allocated:
1. Earnest Money Is Applied to the Down Payment
In most cases, the earnest money deposit goes toward the buyer’s down payment. For example, if you’re buying a $300,000 home and putting down 10% ($30,000), your $5,000 earnest money deposit would count toward that amount, leaving you with a remaining $25,000 to pay at closing.
2. Earnest Money Can Be Used for Closing Costs
Buyers also have the option to apply earnest money toward closing costs. These costs may include:
- Loan origination fees
- Title insurance
- Attorney fees
- Appraisal costs
- Prepaid property taxes and homeowners insurance
3. Earnest Money May Be Credited to the Buyer in Other Ways
If a buyer has already covered the full down payment and closing costs through other funds, the earnest money may be credited back to the buyer at closing. This typically results in a reduction in the amount owed at closing or a refund check issued to the buyer.
When Can Earnest Money Be Refunded?
Earnest money is refundable in certain situations, depending on the contingencies included in the purchase contract.
1. If the Buyer’s Offer Is Rejected
If a seller declines the buyer’s offer, the earnest money is fully refunded since no agreement was reached.
2. If a Contingency Allows the Buyer to Back Out
Many real estate contracts include contingencies that protect the buyer, such as:
- Financing contingency: If the buyer is unable to secure a mortgage, they can withdraw from the contract and receive a refund.
- Home inspection contingency: If the inspection uncovers major issues and the buyer decides not to proceed, the deposit is returned.
- Appraisal contingency: If the home appraises for less than the purchase price and the seller won’t renegotiate, the buyer can cancel the deal and recover the earnest money.
3. If the Seller Backs Out of the Deal
If the seller cancels the transaction without a valid reason, the buyer is typically entitled to a full refund of their earnest money deposit.
When Can Earnest Money Be Forfeited?
There are situations where the buyer could lose their earnest money:
1. If the Buyer Backs Out Without a Valid Reason
If a buyer changes their mind and withdraws from the contract without relying on a contingency, the seller is usually entitled to keep the earnest money as compensation for lost time and opportunities.
2. If the Buyer Misses Deadlines
Real estate contracts have specific deadlines for inspections, financing approvals, and other requirements. If a buyer fails to meet these deadlines, they could lose their earnest money.
3. If the Buyer Violates the Contract Terms
Failing to follow the terms of the purchase agreement-such as not securing financing or delaying closing without cause-can result in forfeiting the earnest money.
How Buyers Can Protect Their Earnest Money
Since earnest money represents a significant investment, buyers should take steps to protect their deposit throughout the home-buying process.
1. Include Contingencies in the Contract
Always ensure your purchase agreement includes contingencies for:
- Financing approval
- Home inspection results
- Property appraisal
These contingencies provide an exit strategy if unexpected issues arise.
2. Work with a Trusted Escrow Company
Never give earnest money directly to the seller. Instead, deposit it with a licensed escrow company or title company to ensure proper handling.
3. Keep Track of Deadlines
Stay on top of all contract deadlines, including financing approvals, inspections, and closing dates, to avoid unintentional forfeiture.
4. Get Everything in Writing
If negotiations lead to contract changes-such as extending deadlines or adjusting contingencies-ensure that all changes are documented in writing and signed by both parties.
At closing, earnest money is typically applied toward the buyer’s down payment or closing costs, ensuring it contributes to the home purchase. However, buyers should be aware of when they can reclaim their deposit and when it may be forfeited.
To protect earnest money, buyers should understand contract terms, include contingencies, and work with reputable escrow services. By being informed and cautious, buyers can navigate the closing process smoothly and avoid financial pitfalls.