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Hand holding a money back passing to hand holding a toy house

What is an Earnest Money Deposit and why does it go into Escrow?

For that matter, what is escrow?

Let's start by defining "escrow." According to Dictionary.com, escrow is a contract, deed, bond, or other written agreement deposited with a third person, by whom it is to be delivered to the grantee or promisee on the fulfillment of some condition.

When you make an Earnest Money Deposit, you probably want that money to go to a neutral third party, to make sure it's handled properly, right? That's where escrow comes in.

What is an Earnest Money Deposit?

When you agree to purchase a home, there is typically an "earnest money deposit" included in the agreement. This is money you put into the transaction in good faith. Should you walk away from the transaction, that money could be forfeited to the sellers. "So," you ask, "how does all of this work?"

Who, What, Where, When and Why

The journey to homeownership is made up of lots of different processes and "parties." The two most fundamental parties are, of course, the buyer and the seller. That's just the start of it, though. There are also the real estate agents, loan officers, underwriters and closers - all people you'll meet during the homebuying journey (although not necessarily in that order). A lesser known party is a third party - or what the industry sometimes refers to as an "escrow" officer. This can be an attorney, title company, etc. Each state has their own structure of how real estate transactions are settled. An escrow officer serves as a neutral third party when the homebuying process has actually reached the point of money changing hands.

Through an escrow officer - or the entity that serves this function - the home buyer makes an earnest payment that goes toward the purchase of the home. It's called "earnest" because it's an indication that the person buying the home is genuinely interested in buying a house that's for sale and is willing to part with something of value - cash - as a result. When the real estate transaction goes through successfully, the earnest money is generally counted toward the purchase of the home.

You may ask why that money doesn't go straight to the previous owner of the home. The main reason is that there are usually more things that have to happen before the deal is finalized. By holding the money in escrow - a limbo, of sorts - it provides both the seller and buyer with certain protections and assurances that the money will eventually change hands, but only after various terms and conditions are met, those which are generally mutually agreed upon.

In short, escrow officers - who could be an attorney or representative of a title company - serve as failsafes to assure that the actual purchase of the home goes as planned and that all sides are satisfied by the terms of the sales agreement. Alternatively, the money that's being held may return to you if the deal falls through because of the seller - like if the seller suddenly has a change of heart.

How much is an earnest money deposit?

That depends on you. The size of the earnest money deposit is part of the negotiation between the buyer and seller. The contract that's written up, often referred to as the "sales agreement," "purchase agreement" and "agreement of sale," details the terms of the earnest money deposit and how it may be drawn on, distributed or affected by unforseen events. It's a good idea to walk through the contract with your real estate agent and understand the ways your earnest money deposit could be affected.

See? Now you can swing these terms around with the best of them. Makes the whole process a little less intimidating, doesn't it? You've got this. And if you have questions, ask your favorite RMS loan officer.