Earnest money is an important part of the home buying process. It shows the prospective buyer is committed enough that they are willing to put down money to keep the process moving forward. This is not a deposit, that comes later, but it can be applied to the deposit at the appropriate time.
When a seller is working with a realtor and the home is on the market, that realtor is showing the home to many prospective buyers. Once a prospective buyer is interested enough to put down earnest money, the home goes under contract and is essentially taken off the market. Without earnest money, a potential buyer could make offers on many homes, taking them off the market until they decide. Earnest money helps protect the seller while the home is off the market and under negotiation.
Assuming the process continues to completion, the earnest money is usually applied to the amount needed for the deposit.
How much is an agreeable amount of earnest money? It depends on the real estate economy and the wishes of the buyer and seller. On average, it’s usually 1 – 2% of the purchase price. In a real estate market where homes aren’t selling quickly, the seller may ask for only 1% or less; where demand is high, they may ask for 2% or higher. If both parties are represented by real estate agents, the agents will negotiate to achieve an acceptable amount agreeable by both parties.
At this point, a purchase agreement is drawn up by the realtor and the potential buyer gives the earnest money to show their commitment. Within the purchase agreement will be a provision to return the earnest money to the buyer if the deal should fall through. For example, if the home inspection reveals problems with the home and the two parties are not able to come to an agreement, or if the buyer is not able to get financing.
Once the inspection is completed, both parties are still committed and the potential buyer has secured financing, the process moves on to the actual closing. At this point, the earnest money is applied to the deposit.
Earnest money is a fair way to allow the home to be taken off the market while negotiations begin.