Can You Use Earnest Money for Closing Costs?

Real estate transactions involve two financial components: earnest money and closing costs. Earnest money is an initial deposit made by a buyer to show serious intent to purchase a property. Closing costs encompass various fees and expenses incurred by both parties to finalize the sale. This article clarifies the roles of earnest money and closing costs, explaining how earnest money contributes to a buyer’s overall financial obligation at closing.

Understanding Earnest Money

Earnest money functions as a good-faith deposit, signaling a buyer’s commitment to a real estate purchase. It is paid after the offer has been accepted, within one to three business days following the signing of the purchase agreement. The amount ranges from 1% to 3% of the home’s purchase price.

Upon payment, earnest money is not given directly to the seller. It is held by a neutral third party, such as an escrow agent, title company, or real estate attorney, in an escrow account. This secure holding prevents either party from accessing the funds until specific contract conditions are met or the transaction is terminated. The terms for release or potential forfeiture are detailed within the purchase agreement.

If the real estate transaction proceeds successfully to closing, the earnest money is credited back to the buyer. Earnest money may be forfeited to the seller or returned to the buyer if the deal does not close. Buyers receive their earnest money back if the transaction fails due to conditions specified in the purchase agreement, known as contingencies. Common contingencies include successful home inspection, the property appraising for at least the purchase price, or the buyer securing financing.

Conversely, earnest money may be forfeited to the seller if the buyer breaches the purchase contract or backs out for reasons not covered by agreed-upon contingencies. For instance, if a buyer changes their mind without a valid contractual reason or misses key deadlines, the seller may be entitled to keep the deposit as compensation for taking the property off the market.

Understanding Closing Costs

Closing costs are various fees and expenses incurred by both buyers and sellers to complete a real estate transaction, separate from the home’s purchase price. These costs cover the services required to process and finalize the mortgage and transfer property ownership. For buyers, these expenses range from 2% to 5% of the total loan amount or purchase price.

Buyer-specific closing costs include a range of fees. Lender fees comprise loan origination fees, which cover the administrative costs of processing the loan, and may be between 0.5% to 1% of the loan amount. Other lender-related costs include appraisal fees, ranging from $400 to $700, and credit report fees. Title-related expenses include title insurance premiums, which protect the buyer and lender from future claims against the property’s title, and escrow fees for the services of the escrow agent.

Additional closing costs for buyers can involve legal fees. Recording fees are paid to the local government to officially record the transfer of ownership documents. Buyers pay for prepaid items, which are expenses paid in advance for the upcoming period, such as property taxes and homeowners insurance premiums. The specific combination and amounts of these costs are itemized on the Closing Disclosure, a document buyers receive prior to closing.

How Earnest Money is Applied at Closing

Earnest money is not “used for” individual closing costs in isolation. Instead, it functions as a credit that reduces the total cash amount a buyer needs to bring to the closing table. This total cash amount includes both the down payment and all associated closing costs.

The earnest money deposit is applied as a credit against the buyer’s overall financial obligation at closing. This means the earnest money offsets the total cash required from the buyer’s personal accounts. For example, if a buyer’s total cash requirement for the down payment and closing costs is $50,000, and they have already paid $5,000 in earnest money, the amount they will need to bring to closing is reduced to $45,000.

This credit is clearly reflected on the Closing Disclosure document, which provides a comprehensive summary of all charges and credits in the transaction. The application of earnest money as a credit simplifies the financial process for the buyer, as it reduces the final amount of money that must be transferred on the closing day. Buyers should review their Closing Disclosure to ensure the earnest money credit is accurately reflected and that all other charges are as expected.