Understanding Earnest Money

Earnest money is more important and more interesting than it is generally given credit, especially in a competitive market. Before I moved into real estate, I recall talking to agents who saw it as a kind of relic of the past or just a footnote in the process. In fact, it’s your opening move in creating a connection with the seller. Through the earnest money, we can convey the seriousness of our commitment to seeing the transaction through to completion. We can also signal the degree to which we are excited about this house, which might be a tipping point in a competitive situation.

So what is earnest money really? Put simply, it’s money offered up front by the buyer that will be held by a neutral third party until contractual conditions are met. It’s primary purpose is for the buyer to demonstrate to the seller that they aren’t going to walk away from the deal, because if they do so the seller can collect the money. It’s protection for the seller in agreeing to move forward with this buyer, knowing that there may be other factors that end the deal, such as a failed inspection or appraisal.

Let’s say I’m selling a house for Walla Walla’s median selling price of $300,000. If someone brings an offer with earnest money of say $500, the seller might take caution as the buyer can walk away and only lose the $500. For example, their strategy might be that they are still looking at other houses and just want to hold your house off market temporarily. On the other hand, if an offer came in for that same house with earnest money of say, $5000, that buyer is signaling their interest and commitment. All other things being the same in the offers, the seller would be better off accepting the offer with the higher earnest money.

So what happens if we make an offer on a house, but one of our contingencies falls through. Do we lose our earnest money? No, and that’s why they were “contingencies.“ When we wrote the contract, we explicitly said “we’ll buy your house if the inspection, financing, and appraisal are acceptable.“ If they aren’t found to be acceptable and we can’t come to a negotiated agreement, the contingency isn’t met and the buyer can walk away and not lose their earnest money. On the other hand, if the contingencies are met and the buyer suddenly finds another house they prefer, the earnest money becomes the penalty for walking away from the agreement.