What Is Earnest Money and How Does It Work?

If you've been researching real estate purchases or talking to a realtor about touring a home, you probably have heard the phrase "earnest money" pop up.

Earnest money is one of those terms that sounds pretty archaic and might throw off people new to the real estate world.

Purchasing a house will always require earnest money, but it can be hard to understand what that means at first.

If you're confused about this term, how it plays into the home-buying process, and why it's still a thing, keep reading. We've got the answers for you.

What is Earnest Money?

Earnest money is a deposit a homebuyer puts down at the time of contract to show good faith and their intention to buy a property.

• Earnest money is deposited into an escrow account until closing day and counted toward the home purchase price.
• The earnest money deposit can be the total amount of downpayment or just a percentage of it.
• If you are afraid your earnest deposit is not refundable if something happens to your deal, you should speak with your real estate attorney.
• Earnest money can also be requested when applying for a rental apartment. Always ensure you know the refund policy before you hand over any funds.

What Is Earnest Money, And Why Is It Used?

Most people know that buying a home is a long process that can fall through at almost every twist and turn.

To understand the reasoning behind earnest money, you have to understand what once used to happen.

In the past, there was a tendency for people to pretend to be willing to buy multiple houses before they decided on one.

They would put "holds" on multiple houses to give themselves time to decide, but only buy one while letting the other sales fall through.

To prevent this, homeowners and realtors asked potential buyers to place a portion of the home's price in an escrow account until closing.

This money is physical proof that you have an actual intent to buy the home and are honest about your plan.

Earnest is an old-school way of saying intend "honest," which is where the term earnest money is derived.

Being earnest in your intentions is vital because it prevents the sellers from missing out on someone who would love the house if you're not ready.

Read on: What You Need to Know Before You Buy Property in New York

When is the earnest money required?

Are you worried about having to plunk down cash before you even tour a building?

Don't you be? Earnest money comes into play when you make an offer on a home, and the seller accepts the offer.

Is earnest money the same thing as a downpayment?

It's already a given that most homebuyers will have to put down a downpayment. So, how is it any different from earnest money?

Earnest money is directly related to the downpayment in that the money is debited from the downpayment.

In some cases, the earnest money will be a percentage of the downpayment, depending on the conditions both sides agree to. In others, it will be the entire downpayment.

Generally, putting down the entire downpayment as your earnest money deposit will increase the faith of your sellers.

It shows your willingness to put your money where your mouth is and your liquidity and ability to afford the house or mortgage.

How do you give earnest money?

Earnest money is made as a certified check, wire transfer, or personal check deposited into an escrow account that will be accessed at closing.

If the earnest money is just a portion of your downpayment, the remaining amount will be paid at the closing table.

If you feel lost, your real estate attorney will walk you through the process.

How Much Earnest Money Do You Have To Have To Reserve A House?

This all depends on several factors, including the community you're moving into, local laws, and the agreement you made with the seller.

Generally speaking, you must put down 1 percent to 2 percent. Some communities may require a flat fee.

Not sure how much money you should put down? Here are some guidelines and advice to follow:

• Check the contract and realtor agreement. The earnest money you should put down will be in the contract.
• If you haven't put the offer out yet, ask the seller what they feel would be good. The seller will be able to give their own guidelines; if they can't, their realtor will be happy to do it for them.
• Check your co-op or condo's policy. If you purchase a co-op or a condo through financing, the company in charge will have policies regarding the earnest money requirements.
• Though the standard earnest money deposit is 1 to 2 percent, hot housing markets like NYC might see fees as high as 5 to 10 percent. The earnest money deposits tend to be a reflection of the demand people have for that home.

Do I have to fill out any tax forms with earnest money?

If the amount of earnest money you must put down exceeds $9,000, federal law will require you to fill out a W-9.

This is only done since the money you place in escrow can receive interest, and you might want to collect that while it's waiting there.

However, this may not be worth it if the earnest money is less than $9,000, although the seller may ask you to do so.

Some brokerages will require you to fill out the W-9 form regardless to protect themselves in case of an audit.

You will be asked for your social security number in the case of a W-9 form. If you don't feel comfortable sharing your social security information, speak with your attorney.

Is earnest money refundable?

Whether or not you get the money back depends on what happens with the sale and transaction.

If the sale goes through, the earnest money is used to help with the closing costs.

However, if you decide against buying the home for reasons that don't have anything to do with the inspection, the seller keeps the fees.

If the sale falls through due to an inadequate inspection or appraisal, the money will be refunded to you.

Moreover, if the seller decides to renege on the sale, you should also expect to get the money back since the deal fell through, which is not your fault.

The terms are not always black-and-white, so you must discuss the what-ifs with your attorney before taking action.

It is still possible for a buyer to walk away with your earnest money even in the case of leaving the deal due to a more frivolous reason, so it's not an open-shut cake.

How To Keep Your Earnest Money Safe

The problem many people have with purchasing real estate is the paperwork and the bureaucracy of it all.

Because things get so confusing, there have been occasions where people have lost their earnest money.

These tips below will keep it from happening to you:

• Make sure that a reputable group handles the earnest money and escrow. You shouldn't trust your earnest money with just anyone. It would be best to let the escrow account and its deposits be handled by a trusted bank, escrow firm, lawyer, real estate brokerage, or title company. You should never directly hand the check to the seller!
• Keep a close eye on your contract. Your sales contract is there to protect both you and the seller. Please read it and follow it down to the letter. Otherwise, you might have the deal fall through and lose your deposit in the mix.
• Ensure every contingency and note you've made about the house is in the contract. Without noting everything down, you won't be able to back out of a deal if you decide it's not a good option.
• If your seller reneges on part of the agreement, speak up and get your refund. Let's look at an example of this in action. Jared is buying a house from Julie, and they both agree that Julie will fix the leaky ceiling in the kitchen by the time the move-in date arrives. The date came in, and Julie still hadn't fixed the roof. Jared cancels the transaction and gets his refund. Without him keeping an eye on the contingencies, he would have had to pay that repair money out of pocket or lose his earnest money.

How should you view earnest money?

Many homebuyers consider putting down earnest money a pain, but you shouldn't see it this way.

Earnest money is a significant step that shows just how close you are to closing your home, and it also acts as a way to protect yourself from the seller acting in bad faith.

You start the countdown timer to your move-in date by plunking down your earnest money.

That's a massive push in the right direction and is worthy of celebration any way you look at it.

Other Real Estate Uses of Earnest Money

The other transactions where earnest money may be utilized are with rentals.

Often, but not always, many brokerages and property management companies in New York City may require an applicant to put down an earnest money deposit.

The earnest money deposit may be as little as a couple hundred dollars to the total security deposit amount.

Like in the case of a downpayment, the more you put down, the more it shows your intention of signing a lease.

Also, like sales, it can be a placeholder and does not guarantee you will get the apartment.

Earnest money is usually requested during your application and credit check.

In some situations, you can use a credit card to deposit the earnest money, while others may require refundable guaranteed funds, depending on the brokerage or company.

Make sure you read up on their refund policy just in case the application doesn't work out.