Earnest Money Deposits: Frequently Asked Questions
If you're here, you probably want to know what earnest money is, how it works, and most importantly how not to lose it.
As always, I'm here to break it all the way down for you.
If you're new here, my name is Lili and this is where I talk about real estate investing and personal finance to help us all achieve a little bit more financial freedom.
Today, we're going to talk about earnest money. We're going to dive deep and define what earnest money is, if it's even required, how much you have to put down, and of course what you have to do to make sure that you don't lose your earnest money.
So you're probably interested in earnest money because you're thinking about purchasing or wholesaling a piece of real estate.
Whichever one it is, I'm going to start off with this very important point: I'm not here to teach you ways to get around putting down earnest money.
If you're trying to buy or wholesale a house, that's an asset that costs tens of thousands or even hundreds of thousands of dollars, and earnest money is part of the business of buying assets that cost that much money.
So my advice to you and what I'm going to share with you today is to learn what earnest money is, how it works, and how to use it to your advantage when you're negotiating and making offers on properties.
Doing that is a much better use of your time and energy than trying to find sneaky ways around putting down earnest money.
Don't pay the earnest money deposit to the seller
The second thing I'll tell you is that earnest money is not paid directly to the seller. It goes to a third-party, either a title company or lawyer, and they hold on to it until it's time to actually close on the property.
I'll explain that more in depth in this video, but I wanted to make sure I got that out of the way up front. Do not give the earnest money check directly to the seller.
So with those things out of the way, I'm going to be giving you a complete breakdown of the timeline from when you need to submit earnest money, how it works, and how to get it back if you need to.
But first, let me answer some common questions so that we're all on the same page.
So I think the first thing we should do is define what earnest money actually is. It can be referred to as EMD, or an earnest money deposit, or as a good faith deposit. It really is just a signal of your good faith to abide by what you said in the contract, and actually purchase the property.
Think about it this way. When a seller accepts your offer to buy a piece of property and they sign a contract with you, they are no longer legally allowed to sell that property to other people.
But if you weren't actually serious about buying the house, they would never want to sign that contract with you and take away all of their other options from other people who might actually want to buy it.
So you submit earnest money to the seller to show that you're actually serious about buying the property. You're basically putting your money where your mouth is.
But that doesn't mean that you'll lose that money if you decide you don't want to buy the property, or you can't buy it.
But we'll get into that in a moment.
Are earnest money deposits required?
Next question: "Is earnest money legally required?"
If you're buying or wholesaling a house that is on-market using a site like Redfin or Zillow, you're gonna have to put down earnest money.
Like I mentioned before, when you make an offer on a house and it's accepted, you and the seller go under contract right then.
But it's not like you go to the bank that day and actually buy the property. There's usually going to be a period of about 30 days from the time you sign the contract to the time where you're actually supposed to purchase it.
But during that 30 days the property is essentially locked up, meaning that if the seller gets another offer - even one that's higher than yours - they are legally not supposed to sell that property.
You have the contract on it, so if you think about it from the seller's perspective, you can understand why they would want you to have some money or some skin in the game to actually buy their house.
And if you don't abide by the rules of the contract, the seller gets to keep your earnest money, which is basically compensation for them missing out on all of the other offers that they may have gotten if they weren't under contract with you.
Properties that are being sold on-market like this are gonna have a real estate agent involved and they are going to look out for their seller's best interest and they're going to ensure that buyers put down earnest money.
Don't waste your time trying to get the agent to make an exception and not require earnest money from you, it's not gonna happen and it looks pretty shady on your part if you try to do this.
Expected amounts for earnest money deposits
So you know you're probably gonna have to put down earnest money. How do you determine how much?
I actually wanted to show you guys a comment that I recently got on a video about a deal I did. The person was nice and they congratulated me about getting the deal and they told me that I could have just put down $50 or $100 rather than the $500 that I put down.
This actually isn't true when you're working with properties that are on market and I was.
Since I found this deal on Redfin and the seller was being represented by a real estate agent, in that case the industry standard is one percent for earnest money. Meaning, one percent of the purchase price is usually what's put down for earnest money.
So a hundred thousand dollar purchase, a thousand dollars earnest money.
That's not a hard and fast rule, and I'll show you how I put down a little bit less.
But if you try to put down $50 and you're offering $76,000 for the purchase - which is what I was offering in this case - the agent is never going to let that fly.
That is immediately going to send a red flag to the real estate agent that something is not quite right, especially if you're wholesaling and making a cash offer.
Think about it from the perspective of the agent and the seller. This person is telling me that they're going to buy my house in just 30 days for 76 thousand dollars, but they only have fifty dollars to put down today? Good luck getting on-market properties with just fifty or a hundred dollars of earnest money.
The rule of thumb that I follow when I'm dealing with on-market properties is that if the purchase price is less than a hundred thousand dollars, I offer five hundred dollars for earnest money.
And if it's more than a hundred thousand dollars, I offer a thousand dollars. This way, I'm working at a little bit less than one percent but it's enough not to put a red flag up for the real estate agent when I send in my offer.
If you want the offer sheet that I use every time I submit an offer on a property you can download it for free at my website: liliinvests.com
So that's on market industry standard, around one percent.
You can usually get a little bit less than that, but not by a ton.
What if you're wholesaling or trying to buy an off-market property where there's no real estate agent involved, and you're just negotiating directly with the seller?
In this case, you don't have to put down one percent. You may not even legally be required to put down anything at all.
It all depends on your state laws and what your contract says. But a good question to ask yourself is does this seller trust me enough or believe that I'm legit enough to buy this property for cash if I'm not putting down earnest money?
If they do trust you, and they're super motivated, you can get away with putting down as little as a dollar, and that just kind of gives the contract a stamp of officialness when you submit it to the title company, which we'll talk about in a moment.
But on the other hand, if you're dealing with a savvy seller or someone who's familiar with the ways that real estate is usually bought and sold, they may ask you to put down more than just a dollar.
In that case, you could offer $50, you could offer $100.
That might work, but make sure you know the difference between on-market deals and off-market deals.
Another question that I get a lot is "Who decides how much earnest money is put down?"
Just like everything else, the price, the closing date, the earnest money amount, it's all negotiable.
As the buyer, you're going to make the offer for what price you want to buy the property for, and in that offer, you're usually going to include your offer for earnest money.
Again, if you want my offer sheet you can download it for free and it'll show you the 10 things, including price, earnest money, closing date, 10 different things that I include with every single offer.
And here's what I'll tell you: I've never had a seller negotiate back with me wanting more earnest money.
They usually care about one thing and one thing only, and that's the price.
But you can use earnest money to show that you know what you're doing or to make your offer a little bit sweeter than someone else's.
On a recent deal, I actually put down a little bit more earnest money than I normally would have because I was competing with an offer for the exact same price and my little bit of extra earnest money made the seller more confident and so they went with me.
And I wasn't worried about that little bit extra because I know how to make sure I'm never in danger of losing my earnest money.
So let's talk about that next.
Are earnest money deposits refundable?
"Is earnest money refundable?"
Like everything else, it's negotiable.
For the most part, for most situations, yes your earnest money is going to be refundable.
There's usually an inspection period, a due diligence period, and a financing contingency. All of these things basically mean after you sign the contract, there's a certain amount of time where you have the opportunity to go get financing from a bank and where you have the opportunity to get a home inspection done.
And if for some reason you're not able to do those things, or the home inspection shows something that you don't like or you don't want, you can back out of the contract and still get your earnest money back.
So what's important is that your contract needs to state exactly what type of contingency you have as well as how long that period lasts.
So let's think about it this way. If you're trying to wholesale a deal and you're offering to pay cash, you shouldn't ask for a financing contingency because you're offering to pay cash.
You shouldn't need to go to the bank to get a loan, and if you're buying a property to house hack, you might need a financing contingency and an inspection contingency where if you don't get the loan from the bank you can back out and get your earnest money back.
But also, if you do a home inspection and they find termites or you know the plumbing doesn't work you can also get your earnest money back for that as well.
Usually these inspections have contingency periods of seven to ten days, but again everything is negotiable and I usually offer 10 business days in my offer sheet and I haven't had any problems with that.
Now, there are times when your earnest money is non-refundable. If you try to cancel the contract outside of your 7 or 10 day inspection period, the seller has every right to keep your earnest money because you didn't abide by the contract.
So whenever you get a property under contract, the first thing that you should do is write down when your inspection contingency ends and then also get it in writing again, maybe in an email to the agent just confirming that everybody is on the same page about when your earnest money is refundable and when it's not refundable.
You could also run into a situation like a property I recently looked at.
The house was in such bad shape that a bunch of investors and wholesalers had actually put it under contract then realized how big of a project it was and during their inspection period they backed out and got their earnest money back.
The sellers were so tired of this that they decided they would only accept offers if there was a non-refundable earnest money.
Now for me, I've got enough contracts coming in that I didn't want to take the risk of losing my earnest money on that deal so I decided to just pass on it and instead start building a relationship with the agent so that if she ever gets any future listings for fixer-uppers she'll send them my way.
The timeline for paying earnest money deposits
Now let's talk about the entire timeline from start to finish of when you need to put down your earnest money, how that's done, and of course most importantly how to actually get it back if you need to.
If we look at this graphic, you'll see that from the time you get an offer accepted and you get a signed contract, you're going to want to get that contract to the title company and also get them your earnest money within 24 to 48 hours.
Especially if you're dealing with an on-market property.
This makes the property unavailable to other buyers and the real estate agent isn't going to risk their license by going around the contract that you already have signed and recorded with the title company.
If you're looking at off-market properties, there are different ways to protect your contract, but that's not my specialty.
But in both situations, the signed contract needs to go to the title company and the earnest money needs to be not far behind.
I personally like to submit my earnest money as quickly as possible, right when the contract is submitted because then I can start marketing the deals to my cash buyers.
So once that happens, the contract and earnest money are in, let's imagine that you have 10 days to perform your inspections or find your cash buyers.
So that's when you get to work, and here we can imagine two scenarios: one where you decide to actually go through with the purchase of the property, and a second where you decide you don't want to actually buy the property and you back out.
So the first one, if you're buying the property for yourself maybe to house hack it and you get your loan from the bank and there's nothing wrong in your home inspection, you really don't have to do anything.
If you're wholesaling the property and you successfully find a cash buyer, this is where you're going to want to get them to put down non-refundable earnest money to cover your earnest money.
Let's break it down. Let's imagine that you initially had the signed contract with the seller and you put down $500 of earnest money.
Well, when you find your cash buyer, you can require them to put down $500 as well.
When the 30 days are up and your cash buyer actually buys the property, the title company will send you your assignment fee as well as your $500 that you initially put down.
The cash buyer's $500 will just go towards their purchase.
Now, let's imagine that for some reason the cash buyer backs out on day 29.
In that case you're outside of your inspection period, so you are going to lose your earnest money to the seller and the cash buyer is going to lose their earnest money to you.
This is why you always make sure that you get earnest money from your cash buyer. It protects you because you might lose your earnest money to the seller. It also kind of makes sure that your cash buyer has skin in the game because they don't want to lose their earnest money to you.
Getting your earnest money refund after cancelling the contract
Now what if you actually don't want to buy the property for some reason or you can't find a cash buyer? If it's an on-market property and you're within your inspection period, just tell the agent and they'll send you a cancellation of contract and an earnest money release form.
Both parties will need to sign it, then it goes to the title company and they'll send you your money back.
If the seller refuses to sign the release, you can take them to court. But that's why I say to get it in writing in two places: both in the contract and as a confirmation after you sign it. Because usually, if you can show somebody in writing two places where they agreed to it, you're not going to have a problem from them.
Now if you're dealing with an off-market property and there's no real estate agent involved, you're gonna have to send the seller the cancellation of contract and the earnest money release form then you have to get it to the title company.
If you're a new wholesaler, it can be a bit easier logistically to wholesale on-market properties because a lot of the documents and official processes will be taken care of by the real estate agent versus if you were off-market and you had to do all of those things yourself.
If you have any more questions about earnest money or anything else be sure to follow me on Instagram @lilinvests.
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