As you’ve searched for your next home, you finally arrive at the perfect property. You and your agent successfully negotiate the terms of the sales contract. Your next step is to provide an earnest money deposit. What exactly is earnest money and where does it go?

Earnest Money Shows How Earnest You Are

When the seller agrees to your offer, the home is placed in a “contract pending” status. This means you alone are the one buying the house and while the seller can take other offers, called backup offers, you have sole rights to buy that property.

Earnest money is an amount, typically one to two percent of the sales price, which is deposited with an escrow agent or title company. If the sales price is $300,000, you can expect to pay up to $6,000 as an earnest money deposit, depending on local custom and strength of the local housing market.

In hotter markets, expect to deposit more earnest money.

Your earnest money deposit is your good faith to the seller that you’re not going to simply back out of the deal upon a whim. The seller took the home off the market on your behalf and your earnest money is hard evidence you’ll proceed as the sales contract prescribes.

Where Does Earnest Money Go?

You won’t give your earnest money check directly to the seller. Instead, your earnest money will be held in trust by a third party. This third party is the closing agent, also called an escrow agent, that will handle the paperwork and the fund transfers at closing.

As long as you’ve done what you were required to do as spelled out in the sales contract, your earnest money will be used toward the down payment and closing costs associated with your purchase. Any earnest money not used for these purposes will be credited to you after closing.

How to Keep Your Earnest Money Safe

Here are some things to remember to make sure your earnest money is safe.

The Closing Date

If the contract says your close date is the 30^th, and you don’t close on or before that date, you stand to lose your deposit as well as the property. Once the closing date has passed and there are other offers pending on the property, you stand the danger of someone else buying the house.

This is why it’s so important to have a knowledgeable, reputable lender who understands the importance of purchase closing dates. It’s not common for the seller to yank your earnest money because you missed the closing date, but it can happen. Why take the risk?

Stick to the Contract

You may also lose your earnest money deposit if the deal falls through for any reason not spelled out in the contract.

Most contracts also have a clause that requires you to get a loan approval from a mortgage company on or before a specific date. This is often referred to as a “financing addendum” or “financing contingency.” It prompts the buyers to get their documentation to their mortgage company in a timely manner.

A sure fire way to lose an earnest money deposit is to simply walk away from the deal upon a whim. Say a buyer makes an offer, it’s accepted and both parties sign the sales contract. An earnest money deposit is made then two weeks later the buyers change their minds for no other reason than they decided they didn’t like the neighborhood after all. By walking away, the would-be buyers lose their deposit money.

It may seem like a good reason to you, but if the reason for walking away isn’t in the contract, it won’t be valid to the seller.

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Getting Earnest Money Back

Okay, so let’s say the deal does fall through for a valid reason.

There are many reasons a the buyer may walk away, but one of the most common is an unsatisfactory property inspection. Say that a home inspector completes the report and you find that the foundation is in need of repair. Your sales contract is contingent upon receiving a satisfactory inspection report. You don’t want to buy a home in this condition. So, you can walk away and get your earnest money back.

Or perhaps the backyard fence is in need of repair. You might counter that the seller reduce the price by an amount equal to fence upgrades. If the seller refuses, the contract is void and your earnest money deposit returned.

Sometimes the home’s appraised value is lower than the purchase price. If the seller refuses to drop the price, the buyer can typically walk away without penalty.

In these cases, the escrow company simply writes you a check for the full earnest money amount, and you start looking for another home.

It Pays To Know About Earnest Money

In short, earnest money deposits ensure the buyers fulfill their side of the bargain and don’t leave the seller with lost time. Sales contracts are real contracts and the language in them aren’t suggestions but performance requirements for both the buyer and the seller. Stick to the contract, and your earnest money will be safe and sound.