What is Earnest Money?

What is Earnest Money?

When a Purchase & Sale agreement(a contract to buy real estate) is written, the potential Buyer agrees to make a good faith deposit, called Earnest Money, into an account held by a neutral third party(escrow company).  The funds act as an additional means, to insure the Seller that the Buyer intends to fulfill their end of the contract.  The Purchase and Sale Agreement(PSA) specifies under what conditions the Seller, or the Buyer, would be allowed to keep the Earnest Money, if the contract is not completed.     

When the Seller accepts the offer, the Earnest Money is then deposited with the escrow company into a trust account, and is then applied to the buyer’s portion of the closing costs, when the sale closes.  The higher the Earnest Money deposit, the stronger the offer.  The reasoning behind this is that if the Buyer makes a higher Earnest Money deposit, they are putting more money at risk, thus more likely to complete the purchase.    Conversely, it is to the Buyer’s advantage to put down as little Earnest Money as possible, if they are not certain that they want to purchase the property. 

If a sale is not completed, there can be disagreement as to which party receives the Earnest Money.  As stated earlier, the PSA specifies under what conditions the Earnest Money is returned to the Buyer or paid to the Seller; however, disagreements do occur.  If there is a dispute between the Buyer and the Seller over the return or forfeiture of Earnest Money, the escrow company holding the funds will disburse them, in following with the instructions set out in the PSA.  If the party who does not receive the Earnest Money disputes the disbursement, they can sue the other party.  This does not happen often, as long as the instructions in the PSA are clear and followed.   

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