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Earnest Money in Real Estate: Definition & Regulations

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

In this lesson, we discuss the definition of earnest money along with how it is paid and held until closing. The role of the salesperson or broker is explained. The lesson also covers when the earnest money is refundable or nonrefundable.

Earnest Money Definition

John and Mary have found their dream home and are ready to make an offer. But how does the seller know they are serious and not just lookie-loos? Earnest money is one consideration in the real estate contract that helps both parties ensure the deal moves forward to closing.

Buyers include an earnest money payment with an offer for purchase as a sign of good faith. It functions similarly to a security deposit. The money acts as leverage to give the seller confidence that the buyer will not back out of the deal. If the deal proceeds to closing, the earnest money typically pays part of the closing costs.

How much money do John and Mary need? This depends on if it's a hot or cold market and on local tradition. In a hot market, John and Mary may need to give a large sum of money. Five percent of the purchase price of the home might be reasonable. In a slow moving market, a smaller amount, like $500 or $1000, may be sufficient to satisfy the seller.

Role of Salespersons, Brokers, and Escrow

When the buyer writes up an offer with their broker or salesperson, they will write a check for the earnest money. The broker will let the seller know the earnest money amount as part of presenting the offer and transfer the money to an appropriate escrow account for holding until closing.

Whether the broker or title company holds the earnest money in an escrow account is up to local laws. Neither the buyer or seller can access this money unless the contract is broken or the deal moves to closing. The escrow account has the buyer and seller as joint owners. Both parties must agree before funds are disbursed. After consulting with their broker, John and Mary decided a $1000 earnest money offer was appropriate.

Refundable or Nonrefundable?

It's been about a month, and after all is said and done, John and Mary are ready to close on their home. Their $1000 earnest money check goes to pay some of their closing costs. Easy enough, but what if something went wrong and they didn't buy this house?

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