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Earnest money is a good-faith deposit you make along with your offer to show that you're serious about buying the house. It's the real estate version of putting your money where your mouth is. You write a check and give it to your agent as part of the offer. Usually, your agent holds the check until you and the seller agree on a price and terms, and then the agent deposits the earnest money in a trust account. At the closing, the earnest money goes toward your down payment on the home or toward your closing costs.
How much earnest money should you include? Enough to show the seller you're serious but not more than you can afford to lose if a problem arises. Different areas have different customary amounts, but it's usually in the range of 1 to 3 percent of the purchase price. In some areas, earnest money may be a flat $1,000, and in transactions where the parties know each other, as in sales to family members, it may involve as little as $1.
If a deal falls through, you may get your earnest money back - or you may lose some or all of it. Laws vary from state to state. For example, some states allow a grace period during which you can change your mind about buying a house without for feiting your earnest money. Beyond such laws, the fate of earnest money when a deal sours depends on what's in your purchase agreement. Both you and the seller must agree on how the money gets disbursed if the sale falls through, so it's important to write contingencies in a way that there's no penalty to you if, for example, the home fails to pass inspection.
Don't sign a purchase offer unless you understand how your earnest money will be held and under what circumstances it will be returned to you. This is one of the reasons that, even in states that don't require a lawyer to draw up purchase agreements, it's a good idea to consult a lawyer anyway.
