When does an earnest money deposit come into the picture?

An earnest money deposit is the amount a potential real estate buyer puts up to show that they are seriously interested in making the purchase. Sellers may ask for this because they are worried that they are tying up their property without a guaranteed payment and discouraging other interested buyers.

The money is usually paid within 24-48 hours after the offer is accepted and is held by a real estate agent or escrow company until the deal is completed.

What is the exact amount in an earnest money deposit?

It’s difficult to determine the right amount of an earnest money deposit. Real estate transactions can be lengthy and complicated, and deals can fall apart for several reasons, for example:

• If the deposit is small, the seller can’t be confident that the buyer won’t leave the deal.
• If there are multiple offers on the table, the seller may not seriously consider the proposal of the buyer who put up the least amount of money.
• If the deposit is large and something goes wrong, the buyer risks losing their initial investment.

Most sellers accept the offer when a buyer offers a large earnest money deposit.

There is no legal minimum for an earnest money deposit. Many real estate agents recommend a deposit of 1% and 2% of the closing costs. However, this amount may be higher or lower based on factors like: 

• Price and type of property sold (e.g., vacant land, resale of an existing home, etc.).
• Prevailing market conditions in your area
• In a seller’s market, with many buyers desiring few property offerings, it makes sense for a buyer to extend a large earnest money deposit to induce the seller to accept its offer.
• In buyers’ markets, large earnest money deposits may persuade sellers to accept a lower purchase price.

Choosing a reasonable number at the start is a good idea. This will decrease the chances of default and make for a less strained relationship between the parties.

How are earnest money deposits made?

Earnest money deposits can take any form that suits the seller.

• Sometimes, the buyer will offer an earnest money promissory note as secure financing instead of making a direct payment. This assures the buyer that it will retain the money deposited if the deal falls through. 
• However, sellers may be reluctant to accept a promissory note instead of cash. If the buyer decides not to go through with the purchase, the seller can sue them to receive the deposit.
• If the parties agree to make the note payable before the closing (e.g., after inspections, within a certain defined period, etc.), giving the seller assurance that the buyer intends to complete the deal and allowing the buyer some breathing room in its payments.

Which conditions must be matched while making earnest money deposits as promissory notes?

The owner must know that the earnest money deposit will be made as a promissory note and not in cash. This fact must also be stated clearly in the purchase agreement. If a seller’s agent accepts the deposit directly as a note without informing the owner, it may be subject to sanctions and fines. If and when the seller accepts this deposit form, the agent must secure the note safely until it becomes payable.

Is the earnest money deposit refundable?

Usually, if the buyer doesn’t perform according to the contract, the seller gets to keep this earnest money. But, if the buyer backs out of the deal, they are entitled to a deposit return. If the deal is closed, the deposit may be used as partial payment of the sales price or returned to the buyer. The laws vary from state to state, and you and the other party may have agreed to different terms in your purchase agreement. Review your contract and local laws for additional information.

Why should you review the promissory note?

Each party should spend time reviewing the promissory note. This will reduce the likelihood of claims that a party did not understand any terms or know their obligations under the document.

When both parties review the note carefully, it ensures that all relevant deal points have been included. Do not assume that certain expectations or terms are agreed to if they are not stated expressly in the document.

How many promissory notes must be signed by the parties?

The parties should sign only one original note, and the seller or escrow agent should keep that document. If you are the buyer, you will want to keep a photocopy of the note and the original note in the hands of an escrow agent or company. After the loan has been paid in full, the seller or the escrow agent should return the original note to the buyer.

Before sitting down to sign, decide your exact goals for the note.

• How much earnest money is sufficient for the deal?
• What interest rates will be applicable?
• Under what conditions will the note become due?

A good agreement takes the intention of the parties into consideration.

Clarify the terms and conditions of your agreement before memorializing them in writing. Depending on the nature of its terms, you may decide to have your note witnessed or notarized. This will limit later challenges to the validity of a party’s signature.

If the agreement is complicated, contact an attorney to help draft a document that meets your needs.

How will the promissory note be used in the purchase agreement?

The use of an earnest money promissory note usually contemplates the existence of a purchase agreement for real property. The purchase agreement is an essential document and should include information about how the earnest money and the note should be addressed. It may also be a good idea to use an earnest money escrow agreement to instruct your escrow agent or company about if and when to release the earnest money and to which party.

Key elements in an earnest money promissory note

The following instructions will help you understand the terms of your promissory note for earnest money. Please review the entire document before starting your step-by-step process.

Introduction

This is the first section wherein you can add details such as the effective date of the note and the parties' names. Clarify who the “payee” and the “buyer” are in this section.

• The “buyer” is usually the party that intends to purchase the real property and is putting up an earnest money deposit for the “payee.”
• The “payee” may or may not be the same entity as the seller. Under some purchase agreements, a buyer will put a note directly in the hands of a third party (like an escrow agent).

Having only one payee has serious consequences. If the buyer defaults, only the party named payee in the note can bring a lawsuit to collect the money. If a broker is the payee (not the seller), only that broker can bring the lawsuit.

Promise of payment

This section states the total amount of the earnest money deposit. This is also where the payee designates where it should be paid (usually its business address).

Earnest money

This clause explains that the note is provided as a good faith (“earnest money”) deposit on a real estate purchase. You can describe the purchase agreement and the property that is being bought.

Payment

The payment section clarifies that the earnest money will be paid immediately when certain conditions are met. Here are some options:

1. The note becomes immediately payable when all conditions specified in the agreement have been met. For example, if the successful completion of a property inspection is required before a deal can close, and that inspection was completed, that condition has been met.
2. The note must be paid within a certain time after the purchase agreement is agreed to and signed. This is usually between 24-72 hours after that time.
3. You can also designate other specific or general conditions after which the note will be paid, like a specific date, receipt of financing, etc.

Prepayment

This section explains that the buyer can pay the payee before it is specifically demanded and that there is no penalty for doing so.

Events of default

This section details the situations in which the payee can declare that a default has occurred under the loan.

Waiver of presentment; demand

This section indicates that if an event of default occurs, the payee doesn’t have to explain to the buyer that they will take action (for example, that it will require immediate payment of the entire note). The payee can take action without providing notice.

Time of essence

This provision allows you and the other party to determine how strictly you want to enforce the time limits in your note. Generally, by including this provision, the payee allows the buyer no leeway – if payment isn’t within the agreed time, the buyer is in default. You usually will enable the buyer some reasonable breathing room if this provision is not added.

Successors and assigns

This section states that the parties’ rights, obligations, and the entire agreement will be passed on to heirs or, in the case of companies, to successor organizations.

Governing law

This section mentions the parties to choose the state and county laws that will be used to interpret the note.

No implied waiver

This section explains that even if the payee allows the buyer to ignore or break an obligation under the note, it does not mean the payee waives any future rights to require the buyer to fulfill those (or any other) obligations.

Collection costs and attorneys’ fees

This section places the responsibility for paying any costs of collecting money under the note on the buyer’s shoulders. For example, if the payee is forced to hire a third party to get its money, the buyer will pay that third party’s fees and costs.

Severability

This clause Protects the terms of the note as a whole, even if one part is later invalidated. For example, if a state law is passed prohibiting choice-of-law clauses, it will not undo the entire document. Instead, only the section dealing with the choice of law would be invalidated, leaving the remainder of the note enforceable.

Frequently asked questions

Can a promissory note be used as earnest money?

Real estate shopping can be risky—and competitive. When up against other buyers, showing a seller you're serious with cash up front may be tempting. An earnest money promissory note is the safer way to demonstrate your commitment to purchase their property and protect your finances.

How do I write an earnest money agreement?

To write an effective earnest money agreement, add the following information:

• Who the buyer is: Have their name and contact information ready
• Who the seller is: Have their information available
• Who the payee is: The payee might be the seller but could be a third party