What is Earnest Money in Real Estate and How Much Is It?

Posted by Excelsior Realty Team on June 8, 2023

When buying a home, earnest money is an important part of the process. But what is earnest money in real estate? It's a deposit made by the buyer to show good faith and serious intent when making an offer on a property. Essentially, it's proof that you are putting skin in the game and that you have some "earnest" desire to purchase this property.

The purpose of earnest money is twofold: first, it helps protect sellers against buyers who may be less than serious about purchasing their home. Or maybe they simply don't follow through with transaction due diligence. 


What is Earnest Money in Real Estate and How Much Is It


Secondly, it can offer peace of mind for buyers by ensuring they "hold" (keep)  the option contract available up until closing time as long as they abide by any agreed-upon terms and conditions listed within their original Purchase Agreement.

As we dive deeper into this topic in our blog post today, we will discuss why understanding how much earnest money should be applied under particular circumstances is important, along with other pertinent details related to doing so.

Key Differences Between Earnest Money and Down Payment

One common source of confusion for many homebuyers is understanding the difference between earnest money and a down payment. While they both involve making payments to purchase a home, there are significant differences between them.

- Earnest money shows that you're serious about buying a property, while down payment refers to the amount paid at closing towards your mortgage.

- The purpose of earnest money is often to protect sellers from lost opportunities while buyers look around or take their time deciding whether they want to proceed with purchasing. 

- On the other hand, your down payment serves as part of what gives lenders confidence in providing mortgages for properties that appear somewhat riskier than more standard properties.

Paying Earnest Money: Process and Best Practices

Paying earnest money is one of the first steps in sealing a deal when buying real estate. With that said, paying large sums of cash can be daunting for most buyers. Let's go over how you can make payments successfully and safely.

  • Accepted Forms of Payment for Earnest Money

Accepted forms of payment for earnest money vary depending on sellers' preferences. The most common payment method is a personal check or cashier's check; however, wire transfers and credit card payments are also becoming more popular. 

If you're not sure which form of payment your seller prefers, ask your real estate agent for guidance. Keep in mind that some methods may require additional paperwork or fees to process the transaction seamlessly.

  • Safely Transmitting and Documenting Earnest Money Transactions

To safely transmit and document earnest money transactions, work with a reputable real estate brokerage firm that uses an escrow account to hold your funds. 

The earnest money deposit should be documented in the purchase agreement, including information about the amount of payment made and how it will apply to your overall closing costs. 

By protecting yourself while documenting these details from the beginning of the process until signing at closing, you'll safeguard against any potential misunderstandings later on in your home-buying journey.

  • Choosing a Trusted Escrow Account for Holding Earnest Money

When choosing an escrow account for holding earnest money in a real estate transaction, select a reputable and trustworthy institution to ensure the safety of your funds. Only use accounts that are properly insured and comply with legal requirements laid out by state law.

Before you decide which escrow company to work with, ask your realtor or mortgage lender for recommendations. They have years of experience working with this process and can help guide you through it seamlessly.

Common Contingencies and Their Impact on Earnest Money

When it comes to buying a home, making an earnest money deposit is just one part of a complex process. It’s common for real estate transactions to be contingent upon various factors that could impact the sale and, therefore, your earnest money. 

  • Home Inspection Contingency: Ensuring Property Condition

Home inspections often uncover any issues with a property and allow buyers to make an informed decision before purchasing it. 

Home inspection contingencies give buyers a certain amount of time to have the home inspected based on the terms of their contract. They can also request repairs or back out of the deal if they are unsatisfied with what is discovered.

This contingency presents several possibilities that would impact earnest money should issues arise during the inspection.

  • Appraisal Contingency: Validating Property Value

When a buyer applies for a mortgage loan, the lender will require an appraisal of the property to determine its market value. 

An appraisal contingency allows buyers to back out or renegotiate if appraisals come in below their offer amount or if there are problems that decrease home value.

This contingency can impact earnest money, whereby purchasers could forfeit some of their deposit based on how they navigate this issue.

  • Financing Contingency: Securing Mortgage Approval

Financing contingencies ensure that buyers receive mortgage approval to purchase the home before a sale can proceed. These types of contingencies outline specific terms for obtaining financing and may give those seeking alternative funding options time to pursue them.

Sometimes, buyers have trouble getting approved for their mortgages. This could impact sellers who took their homes off the market while waiting for such approvals during escrow, which would affect earnest money if buyers could not secure suitable financing within agreed-upon contract terms.

  • Contingency for Selling an Existing Home: Coordinating Transactions

Contingencies regarding selling an existing home often come up in real estate transactions. This contingency protects buyers from being stuck with two mortgages if they cannot sell their current home.

In cases where a contingency is agreed upon concerning the sale of an existing home, money may be held in escrow until such time as coordinating transactions are successfully completed. 

This coordination can add complexity to earnest money retention, depending on the contract terms and timing of all parties and events involved.

Step-by-Step Guide to Safeguarding Your Earnest Money

Protecting your earnest money is one of the most critical steps in any real estate transaction. By following a few simple steps, you can ensure that you keep this deposit safe and secure until closing day.

  •  Step 1: Utilizing Escrow Accounts Effectively

One of the first steps to safeguarding your earnest money is to use escrow accounts effectively. By depositing your earnest money into an escrow account at the start of negotiations and ensuring all subsequent payments go through this channel, too, you can protect yourself from any disputes arising later on. 

This step gives both parties some reassurance about handling and managing funds during real estate transactions.

  • Step 2: Navigating Contingencies to Minimize Risk

Contingencies are clauses in real estate contracts that specify what must happen for the sale to proceed. Buyers can use these contingencies to their advantage by allowing them to get out of a contract without losing their earnest money if certain conditions aren't met (such as financing or home inspection issues). 

However, it's crucial that buyers navigate contingency negotiations carefully and ensure they remain within the timelines specified so as not to risk the forfeiture of earnest money.

  • Step 3: Fulfilling Responsibilities and Deadlines

Another critical step in safeguarding your earnest money is to fulfill all responsibilities and deadlines mentioned in the purchase agreement. If you fail to meet any of the agreed-upon conditions, it may result in losing your deposit.

Key milestones include scheduling home inspections, obtaining mortgage preapprovals or approvals for financing contingencies, spreading details about lead-based paint (if it plainly exists), and other key documentation.

  • Step 4: Putting Agreements in Writing

Putting agreements in writing helps eliminate any ambiguity and ensures that all parties involved know what they are responsible for. A real estate contract must be clear about the terms of the agreement, such as payment dates, contingencies, and the responsibilities of each party.

This detailed documentation will help avoid any misunderstandings or disputes between buyers and sellers throughout their real estate transactions.

Who Gets the Earnest Money Deposit?

After making an earnest deposit to show that you’re serious about purchasing a property, many buyers might wonder whether they retain control of it. Sellers receive this payment and hold it in an escrow account until closing. If all goes smoothly and the buyer is approved for their mortgage loan, then this money will be deducted from what they owe at closing.

However, things can get complicated if either party decides not to proceed with financing or selling their home. In some instances where contingencies are met but the deal falls through because of a breach of contract terms by one or both parties, then who gets to keep the earnest money may need resolving.

How Much Earnest Money Should You Pay?

When it comes to the amount of earnest money someone should pay when trying to buy a home, there's no one-size-fits-all answer. Different sale prices and contract terms dictate how much earnest money is appropriate. 

However, most times the buyer pays 1-3% of the sale price as an earnest deposit in Minnesota. It merely depends on market conditions and negotiations between buyers/lenders/real estate agents/the selling party.

Is Earnest Money Refundable?

Typically, the earnest money is refundable. However, different contract terms may affect these funds' recoverability by buyers and sellers. If a home inspection or other contingencies negatively affect buyer financing plans before closing the sale, they may be entitled to an earnest money deposit refund from the seller.

Here are some key points to keep in mind:

- The amount of earnest money directly affects how much will be refunded

- Terms outlined in purchase agreements dictate whether funds can be returned 

- Keeping records of all transactions related to payments made for due diligence is essential

The Bottom Line: Making Informed Decisions

Whether you're a buyer or a seller, handling earnest money during a home purchase can be overwhelming. However, keeping in mind some essential tips and expert insights may help guarantee successful deals.

Buyers should ensure that their contingencies are written correctly into their purchase agreement. It allows them to get their earnest money back if they need to back out of the deal due to any valid reason, such as a failed home inspection report. On the other hand, sellers should make sure that all conditions are met promptly before releasing funds held in escrow accounts.

At Excelsior Realty, we offer proven strategies that have been verified to be effective through years of experience in Minnesota's competitive real estate market. From figuring out how much to pay for a down payment and closing costs when buying or selling a home to making important legal decisions about who gets refunded when something goes wrong, our experts will be with you every step of the way on this difficult journey.

If there is one thing we believe at Excelsior Realty - it is putting our clients first! We provide personalized service and work tirelessly on behalf of each client until they've found what they desire most - whether purchasing or selling a property! 

So whether you're offloading your current place to get somewhere else, moving right away, or looking to buy your dream one, contact us today!