When a seller accepts your offer on your home, you typically pay an earnest money deposit when you sign the purchase and sale agreement. When the deal closes, this show of good faith usually is applied to your down payment or closing costs. But if something goes wrong with the sale, you could forfeit your earnest money to the seller. Here’s what you need to know to protect your earnest money deposit.
Key Takeaways:
- Buyers often pay an earnest money deposit to the sellers as a show of good faith. It’s credited to the down payment or closing costs at closing.
- You may forfeit your earnest money if you waive contingencies, have to back out of the sale, fail to meet deadlines, or default on the agreement in some other way.
- You can protect your earnest money by ensuring contingencies are in the purchase and sale agreement and using a reputable escrow agent.
What Is Earnest Money?
Earnest money is a good faith deposit you pay upfront to the seller to show you’re serious about the deal. The typical earnest money deposit is between 1% and 3% of the purchase price. You pay the deposit when you and the seller sign a purchase and sale agreement, and the amount usually gets credited to your down payment or closing costs when the deal is finalized.
For the seller, earnest money is attractive because they usually get to keep the deposit if the buyer in some way defaults on the sale to compensate them for their time and the cost of relisting the property.
Buyers should know they can forfeit their earnest money deposit. They should include contingencies in the purchase and sale agreement that refund their earnest money if the sale falls through for reasons beyond their control.
Reasons You Might Lose Your Earnest Money Deposit
Let’s look at potential circumstances where you could lose your earnest money deposit.
You waive contingencies
Contingencies are conditions in the purchase and sale agreement that must be met for the deal to close. Contingencies protect buyers from unexpected problems with the sale. If a contingency is not met, the buyer either can renegotiate the sale or back out of the deal and keep their earnest money.
Common contingencies include:
- Appraisal contingency. This allows the buyer to cancel the deal if the appraisal comes in lower than expected. Mortgage lenders won’t lend buyers more than a home is worth, so a low appraisal would make it more difficult for the buyer to get a loan.
- Home inspection contingency. The buyer can walk away if the home inspection reveals the need for major repairs or that the home is unsafe.
- Mortgage contingency. This contingency lets the buyer back out of the deal and keep their earnest money deposit if they are unable to get a mortgage.
- Home sale contingency. If the buyer’s current home fails to sell by an agreed-upon deadline, the buyer can cancel the sale.
- Title contingency. The buyer may cancel the sale if the title search reveals liens or ownership claims against the property.
- Homeowners insurance contingency. If the buyer is unable to get homeowners insurance coverage, they can cancel the deal.
Some buyers waive contingencies to make their offer more competitive. The seller gets fewer obstacles to a completed sale, while the buyer loses protections — and potentially their earnest money — if something goes wrong.
You back out of the sale
A signed purchase and sale agreement is a legally binding contract. If you back out of the sale for a reason not included as a contingency, you can expect to forfeit your earnest money. The seller also may be able to sue you for breach of contract.
You miss a deadline
Failing to meet an agreed-upon deadline for closing the deal means you’re in breach of contract. You’ll forfeit your earnest money deposit, and the seller could sue you for breach of contract.
You agree to a nonrefundable deposit
Foreclosed properties often are sold on the condition that the earnest money is nonrefundable. Before you put down any earnest money, you should be sure you want to buy the home and be confident you can get sufficient financing.
You buy a home ‘as is’
Some homes are sold “as is,” which means the seller is unwilling to make repairs or fixes. It also means the seller won’t guarantee every aspect of the home is in working condition. If the inspection reveals major problems with the home and you change your mind about buying it, you won’t be able to get back your earnest money.
How To Protect Your Earnest Money Deposit
Earnest money can be a sizable chunk of change you won’t want to lose. Here are some steps you can take to protect your earnest money deposit.
Add contingencies to the sale
Contingencies in your purchase and sale agreement define when you can cancel the deal and get back your earnest money deposit. It’s easier to ask for contingencies in a buyer’s market, when inventory exceeds the demand. In a seller’s market, asking for contingencies may put you at a disadvantage when facing competition from other buyers.
Use a reliable escrow agent
An escrow agent is a neutral third party that holds in trust all funds related to a home sale, including the earnest money deposit. The agent collects and pays out all funds to the correct parties according to the purchase and sale agreement. This ensures a fair and accurate transaction. Your escrow agent can come from an escrow or title company, brokerage firm, or law firm. Make sure you’re using an experienced and reliable escrow agent.
FAQ: Can You Lose Your Earnest Money Deposit?
Here are answers to some frequently asked questions about whether you can lose your earnest money deposit.
If the buyer backs out of the deal for a reason covered by a contingency in the purchase and sale agreement, they get back their earnest money. If the reason is not covered by a contingency, the buyer is in breach of contract, and the seller typically keeps the earnest money.
If the seller backs out of the deal for a reason not covered by a contingency, the buyer typically gets their earnest money refunded.
You’ll get money back at closing if you choose to have your earnest money refunded to you instead of having it credited to your down payment or closing costs.
The Bottom Line on Losing Your Earnest Money Deposit
In an ideal scenario, your earnest money deposit is a piece of your down payment or closing costs that you pay upfront to show the seller you’re committed to the sale. But if the deal falls through for reasons not covered by contingencies in your purchase and sale agreement, you can lose your earnest money deposit. To protect your investment, consider including appropriate contingencies in your purchase and sale agreement and having a reliable escrow agent oversee the transaction.
