What Happens to Earnest Money at Closing?
Understand how your earnest money deposit is applied at closing to reduce your final costs when buying a home.
Earnest money acts as a financial commitment from a buyer in real estate transactions. It signals serious intent to purchase a property, providing assurance to the seller. This deposit is typically an initial part of a home purchase agreement, demonstrating the buyer’s good faith. The amount usually ranges from 1% to 3% of the home’s purchase price, varying with local market conditions. A higher deposit can make an offer more attractive in a competitive market.
Holding Earnest Money
Earnest money is not given directly to the seller. Instead, it is held in a neutral, third-party escrow account, managed by an escrow agent, title company, or attorney. This account holds funds and documents securely until specific purchase agreement conditions are met. This arrangement prevents premature access, ensuring fairness and security throughout the transaction.
The escrow agent has a fiduciary duty to both parties, ensuring all contractual conditions, such as inspections, financing approval, and title clearances, are fulfilled before releasing funds. The earnest money remains in this secure account until the sale is finalized or the contract is terminated.
Applying Earnest Money at Closing
At a successful closing, the earnest money deposit is credited to the buyer, reducing the cash needed at closing. This credit applies toward the buyer’s down payment and/or closing costs. For instance, if earnest money is $5,000 and the down payment is $20,000, the buyer would need to provide an additional $15,000 at closing. This application is a standard procedure in most real estate transactions.
Earnest money transitions from a deposit into a direct contribution towards the home’s purchase. It is an upfront payment that reduces the total financial obligation at closing. If the earnest money deposit exceeds the total amount due for down payment and closing costs, such as with certain no-down-payment loans, the buyer may receive a refund for the difference. This ensures the buyer’s funds are fully accounted for.
Confirming Earnest Money on Closing Documents
The application of earnest money is formally documented on the financial statements buyers receive at closing. The primary document for this is the Closing Disclosure (CD), which replaced the HUD-1 Settlement Statement for most residential transactions in 2015. The Closing Disclosure provides a detailed breakdown of all costs and credits associated with the sale.
Buyers should review the Closing Disclosure carefully. It will clearly show the earnest money as a credit, reducing the “Cash to Close” amount. This credit is typically found in sections summarizing the buyer’s transaction. While the HUD-1 form is less common now, it is still used in specific transactions and would also reflect the earnest money as a credit to the buyer.