Understanding Earnest Money: What It Is and How to Protect It
If you’re unfamiliar with the term, earnest money can sound like another expense to add to the growing list of homebuying costs. In reality, it plays a specific role in the transaction: It shows the seller that you are serious about purchasing the property and intend to follow through with the terms of your contract.
Because an earnest money deposit can represent a significant amount of money, it’s important to understand where it goes, what happens to it at closing and what could put it at risk.
What Is Earnest Money?
Earnest money, sometimes called a “good faith deposit,” is money a buyer agrees to deposit as part of a home purchase contract, and it demonstrates the buyer’s commitment to completing the purchase.
Earnest money is common in real estate transactions, although it is not universally required. The amount can be a fixed dollar figure or a percentage of the purchase price, depending on the property, local practices, the seller’s preferences and the terms negotiated between the buyer and seller.
Is Earnest Money the Same as a Down Payment?
No. Your earnest money deposit and your down payment serve different purposes.
Your down payment is the portion of the home’s purchase price you pay using your own funds at closing. Earnest money is deposited earlier in the transaction as part of your contractual commitment to purchase the home.
If your transaction closes successfully, your earnest money typically doesn’t disappear or become an additional cost. It’s generally credited toward the amount you owe at closing, such as your down payment or closing costs.
Where Does Your Earnest Money Go?
Your contract should identify the party responsible for holding your earnest money, often referred to as the escrowee. The money is generally placed into an escrow account and held separately while the transaction moves toward closing.
In Illinois, earnest money held by a sponsoring real estate broker is considered escrow money and is subject to state requirements governing how those funds are handled.
You should carefully follow the payment instructions provided for your transaction. If you are asked to wire funds, independently verify the wiring information with a known contact before sending money. Real estate transactions can be targets for wire fraud, and fraudulent instructions may look very convincing. After sending the funds, confirm that they were received.
Can You Get Your Earnest Money Back?
Sometimes. The answer depends largely on your purchase contract and the circumstances surrounding the cancellation.
Purchase contracts often contain contingencies that allow a buyer to terminate the transaction under certain conditions. Common examples involve financing, the home inspection or the appraisal. Depending on the language of the agreement, a buyer who properly terminates under one of these provisions may be entitled to have their earnest money returned.
The details matter. A contingency does not necessarily give you an unlimited right to cancel at any point. Contracts typically establish deadlines and procedures that buyers must follow.
Your attorney can help you understand your legal rights under the contract, while your REALTOR® can help you keep track of the steps in the transaction and discuss how different offer terms may affect your position as a buyer.
When Could You Lose Your Earnest Money?
Earnest money can be at risk if you fail to follow the terms of your purchase agreement.
For example, a buyer who changes their mind after applicable contingency periods have passed may not have the same protections as a buyer who properly terminates the contract under an active contingency. Missing contractual deadlines, breaching the purchase agreement or agreeing that some or all of a deposit will become nonrefundable can also affect whether the money is returned.
This is one reason buyers should understand the consequences before agreeing to waive a contingency or making earnest money nonrefundable simply to make an offer more competitive.
How Can You Protect Your Earnest Money?
Understand your contract before you sign it. Know how much earnest money you are agreeing to provide, where it will be held, when it is due and what the contract says about its return.
Pay close attention to deadlines. Homebuying contracts include important dates involving financing, inspections, attorney review, closing and other obligations. Missing a deadline can affect your contractual protections.
Consider contingencies carefully. Waiving protections can sometimes make an offer more attractive to a seller, but it can also increase your financial risk. Talk through the potential consequences with the professionals representing you before making that decision.
Verify payment instructions. If you are sending money electronically, confirm the instructions through a trusted phone number or other independently verified contact. Be cautious about last-minute emails claiming that wiring information has changed.
Speak up early if something changes. Financing delays, inspection concerns and other issues can arise during a transaction. Contact your REALTOR® and attorney as soon as you know there may be a problem. If the parties agree to modify a contractual deadline or other term, make sure the change is properly documented.
Your REALTOR® Can Help You Navigate the Process
Earnest money may be only one part of your offer, but the decisions surrounding it can have real financial consequences.
A REALTOR® who understands the Chicago market can help you determine an appropriate offer strategy, understand local practices and keep track of important steps once your offer is accepted. Your real estate attorney can advise you about the legal terms of your purchase agreement and your rights if an issue arises.
Before putting money on the line, make sure you understand what you are agreeing to and what protections are included in your contract. A strong home purchase starts with an informed offer and a team of professionals who can help you move from accepted contract to closing with confidence.
