Think of earnest money as a deposit to show the seller you are serious about buying their place. Earnest money is typically 1% of the sales price and not less than $1000, but the more earnest money you put down, the stronger your offer is. This is your money and it gets subtracted out of your down payment at closing, it is not in addition to any funds you need to close. You do not lose your earnest money unless you default on the contract. If that were the case then the seller would get to keep your earnest money (again, like a deposit) as recompense for the time they took their home off the market and made it unavailable to other potential buyers….similar to the way hotels take a deposit for a room and only credit it back to you if you cancel within a certain time frame.
You submit the earnest money in the form of a check made out to either the listing or selling broker along with your initial offer. Once you and the seller reach an agreement on terms and have a binding contract, the earnest money is deposited into the broker’s escrow account and held there until closing. If you terminate the contract within your specified Due Diligence period – for any reason – you get your earnest money back in full. If you terminate after the Due Diligence period, in most cases the seller will get your earnest money since you likely would be in default of the contract. There are very specific laws regarding earnest money, escrow accounts, and what happens to that money.
For you numbers oriented people, an example: You are purchasing a $250,000 home with 10% down. A typical earnest money amount would be $2500 (1% of the sales price) which would be deposited immediately into the broker’s escrow account as soon as you have a binding contract (which means you need to have this money in a liquid account before you start house hunting). If all goes well, at the closing table you would need to bring $22,500 for your down payment and your $2500 earnest money would go towards the balance.
Let’s say things don’t go well and something comes up in your inspection that makes you want to terminate the contract. As long as you do so within your Due Diligence period (which is typically about 14 days) you get all your earnest money back.
If your Due Diligence period ends and then 2 days later your financing falls through, or your job decides to transfer you to Timbuktu, or you just decide you no longer want the house…..you can terminate the contract but you will lose your earnest money.