Earnest money is a financial commitment you make to show the seller you’re serious about buying the property.
It’s an amount of money you deposit when you go under contract, and it’s typically held by a neutral third party, like a title company, real estate agent, or attorney.
The main purpose of earnest money is to demonstrate that you’re acting in good faith and intend to follow through with the deal.
For sellers, earnest money acts as a safety net. If the deal falls through because you don’t meet your obligations, the seller can keep the earnest money as compensation for the time the property was off the market. This protects the seller from buyers who may not be as serious about closing the transaction.
For you, the earnest money is also a motivator. Since you’ve put some money on the line, you’re more likely to move forward and meet the terms of the contract to avoid losing it. That risk encourages you to stay on top of your deadlines and complete the purchase.
You’ll usually need to deposit earnest money shortly after your offer is accepted. Most contracts set a deadline, often within three business days of mutual acceptance.
The earnest money isn’t an additional cost; it’s applied toward your down payment or closing costs when you close on the property. So, it’s essentially part of the funds you already need for the purchase. If all goes well, the money helps move you closer to owning the property.
Earnest Money versus Specific Performance
When you’re buying your first investment property, it’s important to understand the difference between an earnest money contract (also known as a liquidated damages contract) and a specific performance contract.
The key distinction lies in the remedies available if one party doesn’t follow through with their obligations.
- Earnest Money Contract – In this type of contract, if you, as the buyer, fail to meet your obligations, the seller is typically entitled to keep the earnest money you deposited as compensation. This is called “liquidated damages.” It essentially limits the seller’s remedy to the amount of the earnest money if the deal doesn’t close.
- Specific Performance Contract – A specific performance contract allows the non-defaulting party to force the other party to follow through on the agreement. If you’re the buyer and the seller defaults, you can legally compel the seller to sell the property. In a contract where you, as the buyer, are also agreeing to specific performance instead of liquidated damages, the seller could force you to complete the purchase instead of just keeping your earnest money.
For most buyers, especially when purchasing their first investment property, the contract you sign will likely be an earnest money contract for your obligations. This means that if you default, the most you’ll lose is your earnest money. However, the contract is often written as specific performance for the seller. This is important because it means the seller is obligated to sell the property to you, and you can take legal action to ensure they do so if necessary.
There are situations where a contract may give you the option to choose between an earnest money contract or a specific performance contract. If this is the case, make sure you check the appropriate box and fully understand what you’re agreeing to. Ask your real estate agent or consult your attorney before signing to ensure you’re clear on the terms of the contract and how they impact your rights and obligations.
Is Earnest Money Required?
When you’re buying your first investment property, earnest money is typically expected as part of the real estate transaction.
It’s a deposit you make to show the seller you’re serious about purchasing the property.
While it’s not technically required by law, most sellers will expect it, and without it, your offer may seem weak or uncommitted.
Earnest money can also serve as consideration for the contract, which is a legal requirement in most agreements. Consideration is something of value exchanged between the parties to make the contract binding, and earnest money often fulfills that role in real estate contracts.
From the seller’s perspective, earnest money can significantly impact how they perceive your offer. A higher earnest money deposit can make you appear like a stronger, more reliable buyer. Sellers may see this as a sign that you’re serious about closing the deal, which can be especially important if there are competing offers.
It’s also important to understand that earnest money is not an additional cost.
Earnest money counts toward your down payment or closing costs, meaning it’s part of the funds you’re already planning to bring to the table to close the deal. Once you reach the closing stage, the earnest money you’ve deposited will be credited toward those costs, reducing the amount you owe at closing.
Who Holds Earnest Money?
When you’re buying your first investment property, the party that holds your earnest money plays an important role in the transaction. They are often called the Earnest Money Holder.
The earnest money is typically held by a title company, a real estate broker, or sometimes a law firm.
They hold the funds in a trust account until the transaction is either completed or terminated. At that point, your earnest money can:
- Applied Toward Your Closing Costs – If the transaction goes through as planned, the earnest money is credited toward what you owe at closing.
- Returned to You – If certain conditions in the contract allow, the money may be returned to you if the deal falls through.
- Given to the Seller/Seller’s Broker – If you default on the contract, the seller or their broker may keep the earnest money as compensation.
- Partially Returned and Partially Kept – In some cases, the money may be split between you and the seller/seller’s broker as part of a negotiated agreement.
To ensure your earnest money is handled properly, it’s critical that you verify who will be holding it and confirm they are a reputable party. You should know exactly where your money is going, and your real estate agent can help you with this step.
Make sure you deliver the funds by the deadline specified in your contract.
Always ask for an earnest money receipt after you deliver the funds. This document serves as proof that the earnest money has been received and is being held in trust. Without a receipt, you may run into complications down the road if there is a dispute over whether the money was properly deposited.
Once your earnest money is deposited, the party holding it will cash your check. The funds will be placed in an escrow or trust account and held there until closing. Make sure you have enough money in your account when the check is deposited to prevent any issues. Whether you provide a personal check or use another form of payment, the funds will be taken out of your account immediately.
Can You Get Your Earnest Money Back?
When buying your first investment property, there are specific conditions under which you can get your earnest money back.
The contract will outline various contingencies—situations where you are allowed to terminate the deal and receive your earnest money refund if certain conditions aren’t met.
From the seller’s perspective, earnest money serves as partial compensation for taking their property off the market. They may feel entitled to keep it if you terminate the deal. During the waiting period, sellers continue to pay property expenses and may believe they deserve compensation if you fail to follow through and close on the contract.
These contingencies in the contract protect you as a buyer, provided you follow the terms and deadlines of your contract.
From the sample contract, here are some key contingencies that might apply, though be sure to check your specific contract for the exact terms:
- Financing Contingency – If you are unable to secure a loan by the specified loan termination deadline, you may terminate the contract and get your earnest money back.
- Appraisal Contingency – If the property doesn’t appraise for the purchase price, you can terminate the contract and receive a refund, assuming you notify the seller within the deadline.
- Inspection Contingency – If the property inspection reveals issues and you terminate the contract before the inspection deadline, your earnest money will be refunded.
- Title Review Contingency – If the title reveals issues that are unsatisfactory, you can terminate before the title deadline and get your money back.
- Due Diligence Contingency – If you find problems in the due diligence documents and terminate before the deadline, you can get a refund of your earnest money.
These are the most common contingencies, but your contract may include others. It’s essential to read your contract carefully to understand which contingencies apply to your transaction and the specific deadlines you need to meet to protect your earnest money.
To further protect your earnest money, negotiate your contract terms carefully. You can ask for additional contingencies that provide more flexibility if issues arise, or request extended deadlines to allow extra time for problem-solving. Keep in mind that the seller may accept or reject these requests—it’s all part of the negotiation process.
The key to getting your earnest money back is to meet the deadlines and conditions set out in the contract. If you don’t meet a deadline, the seller may be entitled to keep your earnest money.
Remember, you can’t terminate the contract simply because you’ve changed your mind or found a better deal. You must have a valid reason as specified in the contract to request the return of your earnest money. Terminating under false pretenses—such as citing a contingency that isn’t the real reason—is not operating in good faith. If the seller suspects you’re not acting in good faith, they could challenge the return of your earnest money.
How Much Earnest Money Should You Put Down?
When deciding how much earnest money to put down on your first investment property, you’ll often see 1% of the purchase price as the typical amount requested.
This is usually stated in the MLS listing for the property, and it’s a common benchmark that sellers expect.
- Offering Less – If you offer less than what’s requested, your offer may be seen as weaker. Sellers might question your commitment to the deal and could pass on your offer in favor of a buyer willing to meet or exceed the earnest money amount.
- Offering the Standard Amount – Offering exactly what the seller is asking for is considered standard practice. It signals that you’re serious and following the norm for the market, which helps your offer stay competitive without standing out negatively.
- Offering More – In some cases, offering more than the standard earnest money deposit can strengthen your offer slightly. It shows the seller you’re highly motivated to close the deal and are willing to risk a bit more money upfront to secure the property.
There are rare scenarios where you might try to offer little or no earnest money, such as when you’re putting no money down on the property and getting seller concessions or financing your closing costs. If you’re not planning to bring any money to closing at all, then you and your agent can try to make the case for putting up little or no earnest money. This is still a bit unusual and a negotiation that the seller can choose not to accept.
Keep in mind that earnest money is usually credited toward your closing costs or down payment. If your earnest money deposit ends up being more than the amount you need to bring to the closing table, you may receive a refund for the difference at closing.
Strengthening Your Offer with Earnest Money
One way to strengthen your offer when buying your first investment property is by increasing the amount of earnest money you put down.
While a larger earnest money deposit can signal your seriousness, it’s important to remember that sophisticated sellers and their agents know that unless you’re waiving contingencies, a higher deposit only benefits them if you fail to meet the deadlines in your contract.
- Non-Refundable Earnest Money – To make your offer stand out more, you can offer to make some or all of the earnest money non-refundable. This reassures the seller that you’re committed, and if you back out for reasons not covered by contingencies, they get to keep the deposit.
- Additional Earnest Money After Milestones – Another strategy is to add additional non-refundable earnest money after key milestones in the process. For example, you could agree to increase the earnest money after the inspection, after reviewing the due diligence documents, or after the appraisal. This shows the seller that with each step you complete, you’re even more committed to closing the deal.
These strategies can help position your offer as stronger in competitive markets where sellers are weighing multiple offers.
Just make sure you understand the risks, especially when you make money non-refundable, as it increases your potential financial loss if the deal doesn’t close.
Earnest Money and Off-Market Deals
In off-market deals, where there’s no MLS listing to suggest an earnest money amount, it’s up to you and the seller to decide what’s appropriate.
The absence of an MLS listing means there’s no set guideline, so the earnest money amount is more open to negotiation. Ideally, you’d like to put up less than buying in the MLS. On the other hand, some sellers may desire as much as possible.
- Negotiating Earnest Money Directly with the Seller – Since you’re dealing directly with the seller, you’ll need to agree on a reasonable amount. Start by understanding the seller’s expectations and find a middle ground that demonstrates your seriousness but without committing large amounts of capital.
- Ensuring Proper Documentation – Even in off-market deals, it’s crucial to properly document the earnest money. You want to have a clear record of the amount, where it’s being held, and the conditions under which it’s refundable or non-refundable. Always get a receipt for your earnest money deposit to avoid confusion or disputes later on.
- Consider Who Holds the Earnest Money – Instead of letting the seller hold the earnest money directly, it’s a good idea to have a title company or closing attorney hold it in escrow. This provides an extra layer of protection, ensuring the funds are managed by a neutral third party. It also reassures both you and the seller that the money will be handled properly according to the terms of the contract. The larger the amount of earnest money, the more I’d insist on a third-party you know, like and trust.
By negotiating directly and ensuring all documentation is in place, you can successfully navigate earnest money in off-market deals while protecting your interests.
What Happens in an Earnest Money Dispute?
Disputes over earnest money can arise when one party feels the other hasn’t met the terms of the contract.
As a real estate investor, it’s important to understand how these disputes happen and what impact they can have on your ability to move forward with future deals.
- Common Causes of Disputes – Earnest money disputes often happen when there is disagreement about whether the buyer has met the deadlines or conditions outlined in the contract. For example, if the buyer tries to terminate the contract outside of the contingency period or without a valid reason, the seller may claim the earnest money should be forfeited. On the other hand, buyers may feel entitled to their money back if they believe they’ve followed the contract’s terms and terminated for a valid reason before the appropriate deadline.
- Handling Earnest Money During a Dispute – If a dispute arises, the title company or whoever is holding the earnest money will typically keep it in escrow until the issue is resolved. This means the funds will be tied up, making them unavailable for other investments. If you’re close on cash reserves and planning to use that money for your next deal, this could limit your ability to move forward with future purchases while the dispute is ongoing.
- Resolving Disputes– Most contracts include terms for resolving earnest money disputes. Mediation is often the first step, where a neutral third party helps both sides reach an agreement. If mediation fails, court action may be necessary, though it can be costly and time-consuming. In some cases, the legal fees to recover your earnest money might exceed the deposit itself. While you can sue for attorney’s fees if you win, you’ll be out of pocket if you lose. It’s crucial to thoroughly read and understand the dispute resolution process in your contract before signing, so you know what to expect if a disagreement arises.