When a buyer enters into a contract on a home purchase, the seller usually takes the home off the market while the transaction moves through the loan process. But if the deal falls through, the seller has to relist the home, which could result in a financial hit for the seller. Upon going under contract, a buyer is usually asked to put down an amount of money to show the seller that they are serious about buying the home. Sometimes called a "good faith deposit," this money is most commonly known as earnest money and usually amounts to 1% - 5% of the home's sale price.
Earnest money is not paid directly to the seller, but instead placed in an escrow account. An escrow account is a neutral third-party location, generally a real estate agent or title company, where money is deposited per the terms of a contract. The money stays in this escrow account until the home purchase transaction is completed or terminated.
If the home purchase transaction goes as planned, the earnest money is then applied to the buyer's closing costs. If the deal falls through due to a failed home inspection or other contracted contingencies, the earnest money is refunded to the buyer. If the buyer backs out for any other reason, the seller keeps the earnest money.
In a competitive market, sellers may favor higher earnest money offers because it shows that the buyers are serious about purchasing their home. A real estate agent will help determine the right amount of earnest money to offer. To learn more about earnest money, click here.