Earnest money is a good-faith deposit you make on a home to show the seller you're serious about buying. The money is deposited after the seller has accepted your offer and is usually kept in an escrow account. When the sale closes, you can keep the cash or apply the money toward the purchase.
Although it's not required, be prepared to offer earnest money when shopping for a house, especially in a tight housing market. Otherwise, you'll have a hard time competing against other buyers.
» MORE: How to make an offer on a house
How does earnest money work?
After accepting an offer, the seller takes the home off the market until the sale closes, which can take more than a month. Earnest money shows the seller that the buyer is serious about purchasing the home. It also provides the seller with some financial protection if the buyer backs out of the deal without a valid reason.
Your purchase agreement will spell out how the earnest money deposit is handled. Typically, the money is kept in an escrow account held by an escrow company, a real estate title company or the seller's real estate agency.
At closing, the earnest money is typically applied toward your closing costs or down payment. However, if you violate the terms of the purchase agreement without a valid reason, you may have to forfeit the deposit to the seller.
» MORE: What down payment is required?
Is earnest money refundable?
Earnest money can be refundable, but it depends on the terms of your purchase agreement. The purchase agreement will include contingencies. These outline the circumstances under which you can walk away from the deal without losing your earnest money.
Common contingencies that let you keep your earnest money deposit include:
Mortgage contingency: You're unable to secure financing within the required timeline.
Appraisal contingency: The appraisal comes in lower than the sale price.
Inspection contingency: The home inspection uncovers problems, and you can't negotiate a solution, such as a lower price or the seller paying for repairs.
Work closely with your real estate agent to decide what contingencies you want to include in the contract.
In competitive markets, some buyers agree to nonrefundable earnest money, which means the seller gets to keep the cash if the sale falls through, regardless of the reason. If you're tempted to use this strategy, make sure you understand the risks and don't offer money you can't afford to lose.
DATA: What's the Homebuying Climate this month?
NerdWallet's Homebuying Climate Index puts a familiar weather label on how favorable conditions are for home buyers.
For August, our analysis puts the Climate Index at 53.2 out of 100, keeping the index in Partly Cloudy territory for the 49th straight month as most variables hold relatively steady.
Read more about the factors affecting this month's index to gauge how they might affect your homebuying plans.
When can the seller keep my earnest money?
The seller may keep the earnest money if you break the terms of the purchase agreement, such as missing deadlines in the contract or deciding not to buy the home because you found a better property.
Have your real estate agent walk you through the entire purchase contract before you sign anything. Make sure you understand your end of the bargain and in what circumstances you would keep or forfeit the earnest money.
» MORE: Steps to buying a house
NerdWallet writer Isabella Angelos contributed to this story.
Is earnest money required?
How do I know how much earnest money to offer?
What is the difference between earnest money and a down payment?
Will I lose the earnest money if the home fails the inspection?
