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Earnest Money | How it works when buying a home

Jim Quist Jan 28, 2024 5:00:00 PM
Earnest money deposit NewCastle Home Loans Jim Quist

Earnest money shows sellers you're interested in buying their house. It's a small amount, like 1% to 3% of the house price, that you deposit upfront when offering to buy the property. In this article, I'll explain how earnest money works so you know what to expect when buying a home.


What is earnest money?

Earnest money is a deposit made by a homebuyer to demonstrate serious intent to purchase a property.

The deposit amount can vary but is typically a small percentage of the purchase price.

Buyers submit earnest money with an offer to buy a property. A neutral third party holds it in an escrow account until the real estate transaction closes.

If you back out of the deal for a reason not outlined in the purchase agreement, the sellers may be able to keep the earnest money. However, if the deal closes as planned, the earnest money goes towards the down payment.


Why pay earnest money when buying a home?

There are a few reasons why you pay earnest money when purchasing a home:

  • Demonstrate to the sellers that you're serious about buying the property.
  • Show the seller that you're financially capable of following through with the purchase.
  • Provide a financial stake in the transaction and help ensure you don't unnecessarily back out of the deal.
  • Create a record of your good faith in the transaction.

Overall, earnest money helps create a sense of commitment and trust between you and the sellers, which can be crucial in ensuring the smooth and successful completion of your home purchase.

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How much is earnest money?

The earnest money you pay when purchasing a home can vary widely. Some home buyers pay as little as $500, while others pay several thousand dollars.

The amount is negotiable between you and the sellers. It depends on various factors, including the price of the home, the strength of the local real estate market, and your financial situation.

The earnest money deposit should be enough to show the seller that you're serious about purchasing the house. Still, it shouldn't be so large that it strains your finances. In most cases, earnest money deposits are a small percentage of the home's purchase price, typically ranging from 1% to 3%.


If you offer the sellers $400,000 to buy their condo, consider depositing $4,000 (1%) to $12,000 (3%) in earnest money upfront.

The sellers may view a larger deposit as a stronger show of commitment and good faith on your part. A larger deposit can be significant in a competitive real estate market when multiple buyers are interested in the same property. 


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Where is earnest money on the sales contract?

Earnest money is part of the real estate contract. For example, in the Chicago Association of Realtors Real Estate Purchase and Sale Contract, the earnest money is on page 1, in section #4

Earnest Money. Upon Buyer's & Seller's execution of this Contract, Buyer shall deposit with ____________________ ("Escrowee"), initial earnest money in the amount of $____________________, in the form of ____________________ ("Initial Earnest Money"). The Initial Earnest Money shall be returned, and this Contract shall be of no force or effect if this Contract is not accepted by the seller on or before ____________________, 20___. The Initial Earnest Money shall be increased to (check one) ______% [percent] of the Purchase Price, OR a total of $ ____________________ ("Final Earnest Money") within ______ Business Days after the conclusion of the Attorney Approval Period (as established in Paragraph 14 of this Contract) (the Initial and Final Earnest Money are together referred to as the "Earnest Money"). The Parties acknowledge and agree that (i) the Parties shall execute all necessary documents concerning the Earnest Money in form and content mutually agreed upon between the Parties and (ii) except as otherwise agreed, the buyer shall pay all expenses incurred in opening an escrow account for the Earnest Money.

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Who gets my earnest money?

Homebuyers give the earnest money to a third party, such as a title company, attorney, or the seller's real estate agency, to hold until closing. Depositing the money with an independent party helps keep the funds secure and neutral until needed. 

Follow the sales contract instructions when ready to pay the earnest money. The sales contract is a legally binding document outlining the deal's terms and conditions, including the home's price, contingencies, and closing date. The earnest money instructions may involve a personal or cashier's check or a wire transfer to the designated escrow agent.

Most Chicago homebuyers pay earnest money in two installments: the initial and final escrow deposits. The initial deposit is due when you submit an offer to buy a property. The final deposit is due after the home inspection and attorney review. 

When buying a place in Chicago, make your check or funds transfer payable to the selling agent's real estate company. Give the check to your agent. She will deliver it to the selling agent's company. The seller's real estate company holds the deposit for safekeeping.


At closing, the company holding your escrow deposit applies the money towards your down payment.

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How does earnest money work?

The following example explains how earnest money works for a typical Chicago home purchase. 


Let's say you're interested in buying a Chicago condo. With your real estate agent's help, you write up a sales contract outlining the terms of your proposal. 

You offer to buy the place for $400,000 by making a $12,000 down payment and financing the rest with a $388,000 home loan. 

  • $400,000 Purchase price
  • $388,000 Loan amount (97%)
  • $12,000 Down payment (3%)

The offer includes $6,000 in earnest money. 

  1. Your agent presents the contract to the seller with your $2,000 initial earnest money check. 
  2. The seller accepts the contract by signing it. 
  3. You make a final earnest money deposit of $4,000 after inspecting the property and deciding to proceed with the deal.

If the sale goes through as planned, the seller applies the $6,000 earnest money deposit toward the home's purchase price at closing. It becomes part of your down payment.

However, suppose the sale doesn't go through for some reason. In that case, the fate of the earnest money will depend on the specific circumstances and the sales contract terms.

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Why do lenders verify earnest money deposits?

Mortgage lenders verify earnest money deposits to ensure they are legitimate and the buyer can afford the property's down payment.

Earnest money is part of the down payment, and lenders must confirm that your down payment is from an acceptable source. It helps to prevent fraudulent activities such as money laundering and protect the integrity of the housing market. 

Lenders ask for copies of the following documents to verify your earnest money deposits.

  • Sales contract
  • Earnest money check or wire transfer confirmation
  • Bank statement proving the earnest money cleared your account

Earnest money can be a gift from an acceptable donor, like a relative. For more information:


Is the earnest money deposit refundable?

Whether earnest money is refundable depends on the terms outlined in the purchase agreement.

In some cases, if the deal falls through due to specified contingencies, such as a failed inspection, the earnest money may be refunded to the buyer. 


Your agent presented a sales contract to the seller with a $2,000 initial earnest money check, which the seller accepted.

You have five business days to inspect the property and complete the attorney review before your final earnest money deposit is due.

During this period, your attorney reviewed the condo association's legal documents and financial statement and determined that the building needs critical repairs.

After hearing the bad news, you canceled the contract within the Attorney Approval Period, so the seller refunded your $2,000 initial earnest money deposit. 


However, if the buyer backs out without a valid reason, the seller may be entitled to keep the earnest money as compensation.

Again, the sales contract outlines the specific circumstances under which the seller may retain the earnest money. You should carefully review the purchase agreement with an attorney or an experienced real estate agent to understand your rights and obligations as a buyer before paying the earnest money. 

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Additional resources for earnest money deposits

Jim Quist NewCastle Home Loans
President and Founder of NewCastle Home Loans. Jim has been in the mortgage business for 20+ years.

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