What is earnest money?

So you found a home and made an offer on it. To secure the deal, your broker mentions you’ll need several thousand dollars for earnest money.

What is it? Can you lose it? Can you get it back?

That’s what this article covers.

Earnest money - what is it?

Earnest money is a deposit you make after your offer is accepted to show that you intend to complete the purchase under the terms of the contract. It is normally held by the closing agent, title company, or another authorized holder until closing or until the contract is terminated.

From the seller’s perspective, you’re asking them to take their home off the market for several weeks to complete a sale.
They don’t want to deal with jokers or tire-kickers that aren’t serious about buying.
The thought is that having the possibility of losing the earnest money should be enough to make buyers work towards completing the sale.

The amount for earnest money is negotiable. Some sellers want 1% of the purchase price, while others are willing to accept a fixed amount like $1,000 or $5,000.

A seller may view an offer with little to no earnest money as weaker than an otherwise similar offer with a meaningful deposit.

Can you lose your earnest money?

Yes. If you breach the purchase and sale agreement without a contractual or legal basis for terminating it, you may lose some or all of your earnest money.

Washington State Note: Washington State recognizes earnest money as a form of liquidated damages (RCW 64.04.005) for failure to complete the contract. Liquidated damages are limited to 5% of the purchase price in Washington State.

Common reasons buyers lose earnest money include backing out of a purchase without an approved exception in the purchase and sale agreement, and failing to follow strict deadlines.

Your purchase and sale agreement has several timelines and exceptions. Being late or missing deadlines puts your earnest money at risk.

Common reasons for losing earnest money

• Missing contract deadlines: Missing dates for inspections, loan approvals, or document submissions
• Backing out without a contingency: Deciding you dislike the house, experienced a change of heart, or had a sudden life shift after signing means you can lose your earnest money.
• Waiving contingencies prematurely: Removing inspection, appraisal, financing, or other contingencies to make your offer look stronger leaves you unprotected if problems pop up later.
• Failing to secure financing after waiving protections: If your mortgage falls through, or if you do not seek financing in a timely manner, your earnest money can be forfeited.
• Breach of contract: Refusing to move forward with closing when all the contract obligations have been met by the seller can cause the earnest money to be lost.

A good agent will keep you focused on important deadlines so you can complete the sale without risk to your earnest money. Losing escrow money is rare in practice.

Can you get earnest money back?

YES! - if you use one of the contingencies built in to the contract.

Whether you get your earnest money back depends on the terms of your purchase and sale agreement. A properly used contingency may give you the right to terminate the transaction and recover your earnest money.

Deciding which contingencies to use is something you should discuss with your broker.

Major contingency types

• Inspection: If your offer includes an inspection contingency, it may give you the right to terminate the transaction during the inspection period, subject to the terms and deadlines in the agreement. Waiving this protection can make the offer more competitive, but it also substantially increases the buyer’s risk.
• Financing: A financing contingency protects the buyer in the event they are unable to get financing (a mortgage) for the home. If the buyer has actively pursued financing and can’t obtain it, the financing contingency gives the buyer an opportunity to terminate the sale and have earnest money returned. Failing to apply for financing or otherwise comply with the contingency puts your earnest money at risk.
• Appraisal: An appraisal contingency or conditions in a financing contingency may protect the buyer in case the appraisal comes back lower than the sale price. A low appraisal can create a gap in financing between what the lender will finance and what the buyer expected to borrow. The buyer can make up the difference with additional funds, negotiate a lower price, or terminate the sale and recover earnest money.
• Neighborhood review: A neighborhood-review contingency provides a period for you to investigate issues that are important to you, such as traffic, noise, schools, commuting, and nearby land uses. If you give a reason within the timeline, you may have a basis to terminate the sale and recover earnest money.
• Title Review: Lets the buyer examine the seller’s title and certain recorded matters affecting the property. Depending on the contract, unacceptable title issues that cannot be resolved may give the buyer a basis to terminate.
• Association Review: Purchasing a home in a condominium or subdivision means becoming part of an association that sets rules and maintains the common areas. The association review contingency gives the buyer time to review the rules, finances, and minutes of the association. Subject to the terms and deadline of the contingency, unacceptable findings may give the buyer may have a basis to terminate the sale and have earnest money returned.

The contract clauses often have expiration dates that are part of the Purchase and Sale Agreement.
Three days, five days, and so on. Your agent should keep you apprised of these deadlines.

Earnest money - what happens after the sale closes?

If the purchase closes normally, your earnest money is credited to you on the closing statement and reduces the amount of additional money you need to bring at closing. If your earnest-money credit exceeds what you owe, the accounting is handled as part of the closing procedure.

Final thoughts

Your exact rights to terminate the sale and have earnest money returned depend on the signed agreement. Review contingency choices and deadlines with your broker before making an offer.