What is Earnest Money and How Much is Enough?

When purchasing a home, not only is there a buyer and seller executing a contract, there is also a monetary consideration called earnest money that binds the agreement. How earnest money is handled can differ from state to state. For the purposes of this article we’ll discuss the norm in Texas.

What is Earnest Money?

Earnest Money is a good faith deposit that a buyer pays out of pocket once a contract is executed. This money is held in an escrow account with a title company. Title companies are unbiased third parties who have very strict rules on how earnest money can be handled. This provides a layer of protection for both the buyer and seller.

How Much Earnest Money is Enough?

Over the years, the average amount a buyer pays in earnest has settled at around 1% of the total purchase price. Due to the fact the earnest money amount is often a term that sellers look at to gauge the strength of the buyer, it may be prudent for a buyer to put up more earnest money than normal in order to make their offer stand out.

Is Earnest Money Refundable?

The short answer is sometimes. Earnest money is meant to be similar to a deposit. There are contingencies in the contract that would allow a buyer to terminate and receive their earnest money back within certain time frames (check out one of our other blog articles: What Does Contingent Mean in Real Estate to learn more about contingencies). The most notable time frames/contingencies a buyer can use to terminate a receive their earnest money back are:

• The Option Period: This is the timeframe (typically 5-10 days) for the buyer to conduct inspections.
• Financing Contingency Period (or “Buyer Approval” period): The timeframe in which the buyer obtains financing approval from the lender based on their credit, income, assets, debts, employment, etc.
• Appraisal: In certain circumstances, the buyer can terminate and have their earnest money refunded if the property does not appraise at the contract price.

How is Earnest Money Refunded to the Buyer if the transaction terminates?

A release of earnest money addendum would be used in order for the title company to release the earnest money back to a buyer if a transaction terminates. This is a promulgated document created by the Texas Real Estate Commission (TREC) that must be signed by all parties including buyer, seller, and both brokers (if there is a listing agent and buyer’s agent). The title company is required to have this form in order to release the earnest money back to the buyer.

The only scenario in which the Release of Earnest Money form may not be required, is if the buyer terminates in their Option Period. Terminating within this time frame creates an “unrestricted right to terminate”, meaning the buyer is not required to produce a reason or show any proof that they meet a contractual requirement to be able to terminate. In this instance a title company can release the earnest money back to the buyer without the Release of Earnest Money document signed. Many title companies have their own internal policy that they require it for their records.

If the buyer is rightfully owed the earnest money and the proper documentation is in order, the title company will either mail a check to the buyer or send a wire. It is important for buyers to understand that if they initially used a personal check for the earnest money, a title company may have a waiting period of 10 days before they can refund it back due to the banks timeframe to ensure the checks clear. That’s why we always recommend the buyer pays via wire transfer, that way there is no waiting period.

How Do You Get Earnest Money Back at Closing?

The earnest money is refunded back to the buyer if the deal gets to the closing table. This comes in the form of a line item credit on the final closing statement. The earnest money is credited back and reduces the amount of the buyer’s required cash to close (which includes the down payment and closing costs). In the event that the buyer is using down payment assistance or the earnest money is greater than the buyers required cash to close, the title company will cut a check or wire the balance back.

How to Protect Your Earnest Money Deposit

The best way a buyer can make sure their earnest money is protected is understanding the contracts and scenarios that would allow them to terminate and receive a refund of their earnest money. Find those contingency dates and put them on the calendar.