To prove that you are serious about buying a house, the earnest money is required before closing. It is also called a good faith deposit.

The seller removes the property from the market when a buyer and seller sign a purchase agreement. The transaction then moves on to closing. The seller must relist the house and begin again if the deal is not reached. This could lead to huge financial losses.

If the buyer pulls out, the earnest money protects him. It is usually around 1 to 3% of the purchase price. Once the deal is completed, it is kept in an escrow account. It will depend on the market. If everything goes well, earnest money can be applied to the buyer’s down payment or closing cost.

The buyer receives their earnest money back if the deal is canceled due to a failing home inspection or other contingencies. A buyer who deposits earnest money may be less likely to make multiple offers on a home and then walk away when the seller takes it off the market.

Example: Earnest Money In Practice

John, Ben, and Stan all have homes for sale. Dennis is a home buyer. He has seen all three houses but cannot decide which one he wants. Dennis can choose from three possible scenarios if all three sellers ask for earnest money deposits.

Situation A: The Forfeited deposit

Dennis isn’t ready to make a decision on one house yet so he makes a good faith deposit for all three. John, Ben, and Stan take their houses off the market and notify their potential buyers that Charlie is interested in the house.

Dennis later decides to purchase John’s home. Ben and Stan have to put their houses back on the market again and look for new buyers. Stan and Ben can keep Dennis’ earnest deposit. This provides them with some compensation for the lost time and money due to Charlie’s withdrawal from the sales.

Situation B: Early Closing Payment

Dennis has no money and doesn’t want to make deposits to any of the three sellers. After some thought, he decides to buy John’s house. He makes one deposit. All goes according to plan. Dennis moves in, and the deposit goes towards the payment of the house.

Situation C: The Failed Contingency

John makes one deposit and Dennis discovers that the house is infested with cockroaches after the inspection. Dennis is able to have a home inspection as part of the purchase agreement. He decides not to buy the house and John returns the deposit.

Why should you pay earnest money?

Although earnest money is not always required, it can be an essential requirement if you are shopping in a highly competitive real estate market. These good faith deposits are preferred by sellers because they want to make sure that the sale doesn’t fail. Both the seller and buyer can have additional insurance by using earnest money.

Because it is directly applied to your down payment and closing costs, earning money can lower the amount that you will need at closing. You’re basically putting some money up earlier in the process.