Explainer: What is Earnest Money?

Earnest money is an important component in real estate transactions, serving as a tangible commitment from the buyer to the seller. Essentially, it's a deposit made by the buyer to demonstrate their seriousness about purchasing the property. This deposit is typically 1% of the purchase price (or rounded up to the nearest thousand dollars our nearest $5,000), is deposited within 48 hours of going under contract (in the state of Minnesota), and is held in an escrow account until the closing of the transaction.

Earnest money performs two important functions 1) it helps protect the seller against disingenuous offers and 2) compensates the seller for time the property is suspended from active marketing. Earnest money acts as "skin in the game" that is put forth by buyers which shows the earnest intent of the buyer to follow through with their offer. After going under contract with a buyer, the seller will generally stop actively marketing the property to the public. If the buyer decides to back out of the deal without a valid reason as outlined in the purchase agreement (e.g., failing to meet contingencies like securing financing or satisfactory inspection results), the seller may be entitled to keep the earnest money as compensation for the time and opportunities lost while the property was off the market.

Conversely, if the transaction proceeds smoothly and reaches closing, the earnest money is  applied towards the buyer's down payment and closing costs. This process helps build trust between the buyer and seller and keeps the transaction moving forward by providing a financial incentive for both parties to adhere to the agreed terms.