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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 much earnest money to offer
A typical earnest money deposit is 1% to 2% of the home price, according to the National Association of Realtors. But that number varies depending on the local real estate market. Sellers are more likely to expect higher amounts in a hot market — when there are more buyers than homes for sale.
Talk to your real estate agent about how much earnest money to offer.
How does earnest money work?
After accepting an offer, the seller takes the home off the market until the sale closes, which can take several weeks. The earnest money helps assure the seller that a buyer is acting in good faith, and it provides them with some compensation 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.
The earnest money is disbursed at closing. Buyers usually put it toward closing costs or the down payment.
You may have to forfeit the earnest money to the seller if you break the terms of the purchase agreement.
» MORE: What down payment is required?
Is earnest money refundable?
The purchase agreement will include contingencies, which outline the circumstances under which you can walk away from the deal without forfeiting your earnest money.
Here are some common contingencies that let you retain your deposit:
Mortgage contingency: You're unable to secure financing.
Appraisal contingency: The appraisal comes in lower than the sale price.
Inspection contingency: The home inspection uncovers problems.
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.
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 if you miss deadlines in the contract or decide not to buy the home because you find 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: 7 steps to buying a house