Shopping for a Home? Be Ready to Make an Earnest Money Deposit

If you want a seller to take you seriously, have the cash available to cover this cost.

When you make an offer to buy a home, you will almost assuredly need to include an earnest money deposit as part of your proposed purchase contract.

An earnest money deposit is money that you deposit with an escrow agent (a trusted third party, such as a lawyer or a title company). It's usually around 1% to 3% of the purchase price, although the amount can differ -- and larger deposits can make your offer more attractive to sellers.

This is important because a deposit shows that you're serious about the purchase, and home sellers typically will decline your proposal if you don't promise to make a deposit.

This can mean you need several thousand dollars at-the-ready if you don't want your efforts to buy your home derailed.

Why you need to make an earnest money deposit

When you make an offer to buy your home, the actual exchange of funds and transfer of ownership won't occur for several weeks or even several months. That's because a home sale is a complicated transaction that usually involves an inspection, appraisal, and a bank review to approve financing.

Once they've accepted your offer, sellers have to list their home as "pending." This means that most other potential buyers aren't going to be interested in looking at the property. Sellers aren't going to want to put their home as pending unless you show that you're serious about going through with the purchase. And that's where your earnest money deposit comes in.

When you make your deposit, you show that you're committed to buying the property according to the terms of the contract. You'll usually make your offer contingent (conditioned upon) certain things occurring, such as a satisfactory home inspection. If those conditions are met and you decide not to go through with the sale, you would lose your earnest money deposit. This protects sellers and gives them confidence to list homes as pending while the other steps necessary for the purchase are completed.

As long as you go through with the sale, your deposit will simply be applied towards your down payment or other purchasing costs at closing. If you back out of a home purchase agreement for a valid reason, such as major problems during the inspection that lead to the contract being canceled, you would get your earnest money deposit back.

While there's clearly a good reason that sellers require this deposit, the problem is that it can be a lot of money to come up with if you aren't prepared for it. This is especially true if you're making a low down payment and securing a mortgage to cover most or all of the cost of the home. You won't get your mortgage to close on the home until after you've had an offer accepted and gone through all the pre-purchase steps. But you may not be able to get that process started without an earnest money deposit.

To make sure your dreams of homeownership aren't derailed by the lack of these funds, it's a good idea to start saving ASAP for the money you'll need to put down as a deposit. That way, you'll be ready to make an offer that stands a far better chance of being accepted when you've found the home of your dreams.