When To Use Earnest Money (& When Not To)

If you’re new to real estate investing, one of the most challenging aspects can be learning the process for finding a property — and going through the paperwork to buy it once and for all. 

There’s many terms that are critical to understand during the purchasing process — one of them being earnest money. 

An earnest money deposit can show your interest in a property and set you apart in a highly competitive real market. 

But when should you use earnest money, and when should you not?

How much earnest money should you put down?

We’ll answer all these questions — and more — in this earnest money guide. 

What is Earnest Money?

When you put in an offer on a property, you can include what’s known as earnest money — a deposit that is held in escrow — as a way to show how interested you are.  

From the seller's perspective, earnest money not only shows your high interest; it demonstrates that you have the necessary funds to purchase the property. 

How Much Should You Pay In Earnest Money?

While the exact amount will depend upon your specific market, an earnest money deposit is generally around 1-3% of the purchase price. 

So, for an investment property at the cost of $250,000, this may look like $5,000.

While this is a general rule of thumb, keep in mind that in a competitive market, a higher earnest money deposit can make an offer more attractive to the seller.

What Happens To Earnest Money At Closing?

If the seller decides to sell you the property, your earnest money deposit will be applied to your down payment and/or closing costs. 

If the deal falls through prior to closing, the earnest money will be returned from escrow to you.

When to Offer Earnest Money ... and When Not To

Earnest money is best used in a market where properties are going fast — and you’ve found a property that, after running metrics such as cash on cash return and gross rent multiplier, you believe will have an advantageous ROI. 

Additionally, some sellers may require earnest money as proof of funds. 

In a market that is not highly competitive, such as an up and coming neighborhood ripe for a fix and flip, an earnest money deposit may not be necessary since you putting in an offer may be enough to get the property. 

Earnest Money Contingencies

Understand Contingencies

Common contingencies include the results of a home inspection, the appraisal value of the property, and the buyer's ability to secure financing.

Pay extra close attention to these contingencies, because if you back out of the deal, the seller may be entitled to keeping all or a portion of your earnest money deposit.

The Bottom Line: Earnest Money

There you have: earnest money is a simple and easy way to let a seller know just how serious you are about a property.

If you're looking for other ways to gain the edge in a competitive market, learn how to use an escalation clause.

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