What Does Earnest Money Mean In Real Estate?

In the real estate context, earnest money is a term of art. This means that the phrase has a specific meaning in a particular field, as the Merriam-Webster dictionary details. In the real estate and business world, earnest money means money put down prior to closing on a home purchase, as Rocket Mortgage explained. In this context, earnest money may also be called a good faith deposit. For further clarity, the Legal Information Institute defines good faith as operating sincerely. The Legal Information Institute also explained that the concept of good faith requires a person to have an honest belief or purpose and requires the faithful performance of certain duties. As Investopedia shared, earnest money allows a buyer additional time to obtain her financing. During this time period she may also perform a title search, have the particular piece of property professionally appraised, and perform pre-closing inspections on the property.

In practice, earnest money is considered to be a material demonstration of a prospective buyer's seriousness about purchasing her residence. As a concept, earnest money can apply to many different kinds of homes, including traditional houses, tiny homes, condos, or town homes. As Cornell Law School outlined, once the home buyer and seller enter the purchase agreement, the seller will remove the home from the market. During this time, the transaction should advance to closing. 

Earnest money helps homebuyers

But, if the deal breaks down in some way during the process, then the seller will likely relist the home. Once the seller relists the property the process begins all over again. With this restart, a different potential buyer may choose to advance on the home. Generally, earnest money is between 1% to 3% of the home's sale price. Typically these funds are placed into escrow until the home-buying deal is finished. As Investopedia detailed, escrow describes a financial instrument. In this particular financial instrument, an asset or the escrow funds themselves are held in a protective posture by a third party. Since the third party operates as an agent, she professionally holds the property on behalf of two other parties who are completing the business transaction.

As Rocket Mortgage explained, the specific amount that is held as earnest money also tends to connect with the customary amount of money in a given market. Overall, if the real estate deal proceeds smoothly though, then the earnest money is applied to the buyer's down payment at closing on the home, reducing the amount due at that time.