Earnest money is a deposit or down payment that represents someone’s good faith promise to purchase real estate. Putting in an earnest money deposit before paying for the property in full allows the buyer extra time to secure financing, conduct inspections, get a property appraisal and anything else needed before the closing date. Earnest money is also sometimes called a “good faith deposit.”
Usually, the buyer pays earnest money after the sales contract is signed, but sometimes it gets paid when an offer on the property is made. The earnest money gets held in escrow, or with a third party, until the deal is closed. Afterward, the money gets applied to the down payment for the purchase of the property.
What Happens After a Contract Is Signed?
When deciding to purchase a piece of commercial property — or any property — the buyer and seller will enter into a contract. However, the contract is not an obligation to buy the property because the property inspection and appraisal could reveal information that makes the property less appealing.
Rather, a contract ensures the property is taken off the market, and then the buyer will put down an earnest money deposit (EMD) that serves as a promise to purchase the property if all goes well. This EMD serves as proof of intent to purchase.
Once the earnest money is put forth, then the buyer can move forward with securing the rest of their finances and scheduling the appraisal and inspection.
Is Earnest Money Refundable?
If something specified in the contract goes wrong, the buyer might be able to get that earnest money back. For example, if the inspection reveals some serious problem with the property, the buyer can then choose to back out of the purchase and get their earnest money back.
However, there are instances in which buyers cannot get a refund of earnest money. If the buyer decides to back out of the deal for reasons that are not specified in the contract, then the seller gets to keep the EMD. If a buyer doesn’t meet the timeline of the contract, then, the seller keeps the EMD.
If the seller terminates the deal of their own accord, however, then earnest money gets refunded to the buyer.
Calculating Earnest Money
Usually, earnest money amounts to 1 to 2% of the total property purchase price, though buyers and sellers can often negotiate the specific amount. Nonetheless, sometimes sellers will specify a fixed amount, rather than a percentage. For homes and single-family rentals, that fixed amount could be in the range of $5,000-10,000, depending on the property.
Protecting Your Earnest Money
Before putting down an earnest money deposit, it’s important to pay attention to a few key details.
- First, make sure there are contingencies in the contract for financing and inspections. For instance, make sure the contract states that if something in the inspection goes wrong, then you get your deposit back.
- Fully understand the terms of the contract. Make sure you read everything so there’s no confusion and so you carry out your end of the deal exactly as agreed upon. If there’s a deadline you have to meet, make sure you’re fully aware of that deadline.
Make sure the deposit goes to a third party and not the seller. The third party could be a real estate broker, an escrow company, a legal firm, or some other entity besides the seller.