When you make an offer on a home, you typically put down an earnest money deposit. This shows the seller you are serious about purchasing the property. But what actually happens to that earnest money deposit when you reach closing and complete the home purchase? Here’s everything buyers need to know about earnest money at closing.
What Happens to the Earnest Money at Closing?
During closing, earnest money is typically applied toward the buyer’s down payment and closing costs. If not fully utilized, the balance may be refunded. However, if the buyer defaults for non-allowable reasons stipulated in the contract, the earnest money might be retained by the seller.
During closing, the buyer and seller sign all the final paperwork and transfer funds to complete the home purchase. These funds include the earnest money deposit.
There are a few things that can happen with the earnest money at this point:
- The earnest money is applied to the buyer’s down payment and/or closing costs. For example, if the buyer put down $5,000 in earnest money on a $300,000 home, that $5,000 would go toward their total payment at closing.
- The earnest money refunds back to the buyer. If the buyer doesn’t need the full deposit for the down payment and closing costs, any leftover amount is refunded to the buyer at closing.
- In the event the property fails to close due to Buyer’s default, the seller may keep the earnest money. This occurs if the buyer fails to close for a non-allowable reason under the contract.
What is Earnest Money?
Earnest money, also known as a good faith deposit, is money a home buyer puts down when making an offer on a house. It shows the seller that the buyer is serious and committed to following through with the purchase.
The earnest money deposit is usually 1-5% of the home’s purchase price. Once the seller accepts the buyer’s offer, the earnest money is held in an escrow account until closing. At that point, it goes toward the down payment and closing costs.
Earnest money gives the buyer some protection too, as it provides consideration which obligates the seller to perform under the contract. If the seller backs out of the deal, the buyer may have recourse against the seller to enforce the sale or receive payment damages. The buyer could also lose the earnest money if they pull out of the contract without a valid reason.
What Happens to Earnest Money If the Deal Falls Through?
If the real estate deal falls apart before closing, what happens to the earnest money depends on the situation:
- Buyer defaults: The seller keeps the full deposit if the buyer breaches the contract.
- Seller defaults: The buyer gets the earnest money back if the seller can’t complete the sale.
- Mutual agreement: If both parties agree to cancel the contract, the buyer will usually get back the deposit. If the agreement relates to a buyer default, the buyer and seller may split the deposit by agreement as well.
- Financing/inspection issues: The buyer typically receives the earnest money back if they’re unable to get financing or the home inspection reveals undisclosed problems.
- Force majeure event: External events like natural disasters can allow the buyer or seller to terminate the contract and the buyer gets the deposit returned.
No matter what, earnest money is meant to encourage follow-through, so buyers should consider an amount they can afford to lose if they can’t close on the home purchase.
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Tips for Buyers on Earnest Money
If you’re preparing to buy a home, keep these tips in mind regarding your earnest money deposit:
- While you should generally not be in a position to lose this deposit, you should put down an amount you are comfortable with.
- Be sure the purchase agreement specifies when and how the earnest money gets returned to you if you need to terminate the contract.
- Understand how a default will impact whether you or the seller gets the earnest money if the deal doesn’t close.
- Work with a real estate attorney to review the earnest money clause, contingencies and your rights and obligations under the contract.
- Ask your real estate agent questions about earnest money and closing. They can explain the process.
The earnest money deposit is an important part of the home buying process. Make sure you understand exactly how it works when you reach the closing table. Knowing what happens to those funds will give you confidence when you make an offer and sign the purchase agreement.
Conclusion
At closing, your earnest money deposit goes toward your down payment and closing costs for the home. But if the deal falls through, what happens to those funds depends on the situation. Make sure you know the earnest money terms in your purchase contract before putting down your deposit. Understanding the earnest money process will give you peace of mind on your path to homeownership.
