What is Earnest Money and How Much Do I Need to Have?

Whenever you want to buy a house, your real estate agent or Realtor will ask you how much earnest money you’ll be giving or putting down. So what is it?

Earnest money is the amount of money you’re willing to put on the line to say you want to buy the property. When I buy property, I typically put down $1,000. As real estate values go up, earnest money will need to go higher as well. It is done in good faith to tell the seller that you mean what you say in your contract, that you’re willing to give up the amount to get out of the contract if you can’t agree to the terms after there has been a mutual agreement. What?! That’s right. Let me explain:

Let’s say you find a house that you are really interested in for $100,000. It’s in a neighborhood where it should be selling for 125K. You put down $1K as earnest money and turn it in with your Purchase Agreement. During the process of purchasing the house, something comes up and you need to back out of the deal. Perhaps you lost your job, your spouse lost his or hers, or you have to move somewhere else now (These things happen all the time-Murphy’s Law…). If you have already removed all contingencies on the deal, meaning you had already told the buyer that you will buy the property and nothing would hold you back, it is possible to back out. What happens in this case, because you are the one backing out, the seller is able to keep your earnest money in exchange for the time their house was no longer on the market (because it was tied up with you buying it). So in this case, the seller gets your $1K and you go empty handed back to your life. If, however, you have to back out of escrow because the seller has an issue or if you want to back out because you found something during an inspection that you don’t want to take on, you’ll get your earnest money back.

In some states, the contract is not valid without earnest money, or some form of value in its place.

So how much earnest money should you put down? I have found around 1% down to be a good number. When I have bought in Ohio, I’ve put down as little as $1. It just had to be something. In those cases, I bought the properties cash and the realtor put out the $1 out of their pocket, physically. In California, I usually only put down $1,000. I did the same in Mississippi and Tennessee. In the end, if your PA (Purchase Agreement) is accepted, you are planning on buying the house. When you buy the house, whatever earnest money you put down goes toward the final amount with which you have to come to the table for the deal to close. So if I have to pay $5,000 at closing and I already put down $1,000 earnest money, I only need another $4,000 at closing.

This can be a very simple concept, but there are lawsuits all around the country around sellers keeping buyers’ earnest money when they shouldn’t. I’ve always returned earnest money when buyers back out. I figure I’ll just get someone else to buy it. The reason others don’t is likely due to either a market price swing due to bad economic news or the seasons have changed, schools in session, or whatever the reason. If you’ve been in escrow for over a month and then decide to back out, you should forfeit your earnest money. That’s another buyer or two the seller could have sold it to, and now they’ll have to start the whole process all over again. In their shoes, they’d rather have the whole amount, but the earnest money is enough to compensate for at least a little of their time.

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