What is Earnest Money in Real Estate?
Earnest money (also called a good faith deposit or earnest money deposit) is a sum of money that a buyer deposits with a third party -- typically a title company or escrow agent -- when entering into a real estate purchase contract. It signals to the seller that the buyer is serious about purchasing the property. If the deal closes, the earnest money is applied toward the buyer's purchase price. If the buyer backs out without a valid contractual reason, the seller may keep the deposit as compensation for taking the property off the market.
Earnest money is not a legal requirement in most states, but it's a near-universal practice. A contract without earnest money tells the seller that the buyer has little skin in the game, making the offer weaker. In competitive markets, stronger earnest money deposits can make the difference between winning and losing a deal.
How much is typical?
The amount varies widely based on market, property type, and the parties involved:
- Traditional retail sales: 1-3% of the purchase price. On a $300,000 home, that's $3,000 to $9,000.
- Wholesale transactions: $100 to $1,000 is common. Experienced wholesalers negotiate the lowest acceptable amount because earnest money is at risk if the deal falls through.
- Competitive markets: 3-5% or more. In hot markets, buyers may offer higher earnest money to stand out among multiple offers.
- Investor-to-investor: $500 to $5,000 depending on the deal size and the relationship between the parties.
Where does earnest money go?
Earnest money is deposited with a neutral third party, not directly to the seller. In most transactions, this is the title company handling the closing. In attorney-closing states, the closing attorney may hold the funds. The money sits in an escrow account until closing, at which point it's credited toward the buyer's costs, or until a dispute triggers its release to one party or the other.
The contract specifies a deadline for depositing the earnest money, usually 1-3 business days after contract execution. Missing this deadline can be grounds for the seller to terminate the contract.
When do you get earnest money back?
Earnest money is refundable under specific contractual conditions:
- Option period termination (Texas): In Texas, the buyer can terminate for any reason during the option period and receive the earnest money back. The option fee is non-refundable, but the earnest money is separate.
- Financing contingency: If the contract includes a financing contingency and the buyer's loan is denied, the earnest money is typically refundable.
- Inspection contingency: If the inspection reveals issues and the buyer terminates within the inspection period, the earnest money is returned.
- Title issues: If the title company discovers problems that can't be resolved, the buyer can usually get the earnest money back.
- Seller default: If the seller fails to perform (can't deliver clear title, refuses to close), the buyer receives the earnest money back.
When does the seller keep earnest money?
The seller can keep the earnest money when the buyer defaults -- that is, when the buyer backs out of the deal without a valid contractual reason to do so. Common scenarios include the buyer simply changing their mind after all contingencies have expired, failing to close on the scheduled date without cause, or breaching other material terms of the contract.
In practice, earnest money disputes can get messy. Both parties must agree on who receives the funds, or the title company holds the money until the dispute is resolved, sometimes through mediation or litigation. This is why contracts should clearly spell out the conditions under which earnest money is refundable.
Earnest money in wholesale deals
Wholesalers approach earnest money strategically. The goal is to put up enough to make the contract credible while limiting downside risk on deals that may not close:
- Keep it low: $100 to $500 is common for off-market wholesale deals. Sellers working with wholesalers are typically motivated and care more about certainty of close than deposit size.
- Use the option period: In Texas, the option period gives wholesalers a contractual exit. If disposition fails (no buyer found), the wholesaler terminates during the option period and gets the earnest money back. Only the option fee is lost.
- Assignment transfers it: When you assign a contract, the end buyer typically puts up their own earnest money. Your original deposit may be returned or credited against the assignment fee.
Earnest money vs option fee
In Texas, these are two separate payments that serve different purposes. The option fee ($100-$500 typically) buys the right to terminate during the option period and is non-refundable regardless of whether the deal closes. The earnest money ($100-$5,000+) is a deposit applied toward the purchase price and is refundable under certain conditions. Both are standard in Texas contracts, but they work very differently.