Earnest Money: What Buyers and Sellers Need to Know

Money for Earnest Money Deposit

What is an Earnest Money Deposit?  It is money that a buyer pays at the time their offer is accepted and they put a house under contract.  Earnest money is deposited with a third party (typically the title company here in the DMV) and is held by them until the contract is either ended prematurely or the sale goes to closing.  More on that below.

How much is an Earnest Money Deposit?  There is no official standard for how much earnest money should be.  Traditionally, listing agents in Virginia and DC expected earnest money to be around 1% of the sales price of the house.  This number has gone up the past couple of years as our market heavily favored sellers.  Sellers like larger earnest money deposits, and they are getting them.  I’ve seen some go as high as 20% of the sales price the last few years.

Is Earnest Money extra money a buyer has to pay?  No!  It is money that is paid up front, but at closing it goes towards the buyer’s downpayment and closing costs.  If a buyer pays a higher earnest money deposit than all of their upfront costs combined, they simply get the difference back at closing.  Earnest money belongs solely to the buyer as long as they follow through on their commitments in the purchase contract.

What happens if they buyer cancels the contract without going to closing?  If a buyer cancels the contract because of an contingency in the contract (ie. Home Inspection, Appraisal, HOA Documents, Financing) the buyer will get all of their earnest money returned to them.  If a buyer cancels after all of the contingencies have been satisfied or removed, that buyer would be in default of contract.  The seller could and often does demand to be compensated when a buyer defaults.  Both buyer and seller have to agree on this compensation.  It will be less if it’s they day after the contract is signed than it would be at the last minute after the seller has moved out of the house.

How would it be settled if their was a default and the parties couldn’t agree? Regardless of how wrong one party or the other would seem to be by the real estate agents or the title attorney holding the earnest money, none of these could make the decision on who should get the earnest money.  Only a court could decide without agreement between the parties.  One party would have to sue the other in order to receive that money.  In my 30 years in real estate, I’ve never seen it go this far.  Both parties typically come to an agreement.

Lessons for Sellers.  A high earnest money deposit makes it less likely that a buyer will walk away from your agreement.  This is what you want.  The amount you need depends on the purchaser; you want a high enough amount that the purchaser would be hurt if they walk away.  Don’t expect to ever see this money, you just want to be able to withhold it from the purchaser to ensure they follow through on their commitments to you.

Lessons for Purchasers.  First and foremost, don’t sign a contract you aren’t willing and able to follow through on.  Make sure you understand what you are committing to and the legitimate ways you can void that contract if you learn new information that makes you change your mind about the house.  If you are sure you will follow through, go high on the earnest money.  It doesn’t cost you anything in the end, and it shows the seller that you can be counted on.  This can make the difference in this current market where sellers have multiple buyers to choose from.

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