Can Earnest Money Be Used for Closing Costs?
Unpack how earnest money is applied in real estate, clarifying its role in reducing your total cash needed at closing.
When purchasing a home, buyers typically encounter two significant financial components: earnest money and closing costs. Earnest money is a deposit provided by the buyer to the seller, signaling serious intent and demonstrating commitment to the home purchase. Conversely, closing costs are various fees and expenses incurred by both buyers and sellers to finalize a real estate transaction, encompassing items such as loan origination fees, appraisal fees, title insurance, and recording fees. Understanding how these two financial elements interact is important. This article will clarify whether earnest money can be applied towards closing costs.
How Earnest Money is Applied
Earnest money is typically applied toward the buyer’s total cash needed at closing, including both the down payment and closing costs. Once a buyer’s offer is accepted, the earnest money, often 1% to 3% of the home’s purchase price, is deposited into an escrow account. A neutral third party, such as a title company, real estate brokerage, or attorney, holds these funds securely until the transaction is finalized.
At the time of closing, the earnest money is released from this escrow account and credited directly to the buyer’s financial obligations. This deposit reduces the funds the buyer must bring to closing. For instance, if a buyer’s total cash requirement for down payment and closing costs is $20,000 and they have paid $5,000 in earnest money, they would need to bring $15,000 to closing. This application ensures the earnest money serves as a direct contribution to the purchase.
Understanding the Closing Disclosure
The Closing Disclosure (CD) is a standardized five-page document detailing all final financial aspects of a real estate transaction. Buyers receive this document typically three business days before closing, allowing time for thorough review. The CD’s primary purpose is to provide a clear, comprehensive summary of the loan terms, closing costs, and any credits applied.
On the Closing Disclosure, earnest money appears as a credit to the buyer, reducing the “cash to close” amount. Buyers should review this section to ensure the earnest money deposit is accurate. This document formalizes how the earnest money contributes to the total funds due from the buyer, showing its allocation towards the down payment or closing costs. Comparing the Closing Disclosure with the initial Loan Estimate helps verify that all financial terms align with prior agreements.
Factors Affecting Earnest Money Use
Several factors can influence how earnest money is ultimately used or if it is retained by the buyer. If the earnest money deposit exceeds the total cash required for the down payment and closing costs, the buyer will receive a refund for the excess. This can occur with certain loan types like VA or USDA loans that may require little to no down payment, or if seller concessions significantly reduce the buyer’s closing costs.
Conversely, earnest money can be forfeited if the buyer backs out of the purchase without a valid reason or fails to meet contractual deadlines. Forfeiture means the seller may keep the deposit as compensation for taking the property off the market. However, purchase agreements often include contingencies, such as home inspections, appraisal results, or loan approval, which protect the buyer’s earnest money. If a deal falls through due to a contingency not being met, the buyer is typically entitled to a refund of their earnest money.