A good faith deposit is money a buyer puts up early in a transaction to show they intend to follow through. In residential real estate, it’s usually called earnest money and typically runs 1% to 3% of the purchase price. The funds sit in a neutral escrow account until the deal closes, at which point they’re credited toward what you owe, or until it falls apart, at which point they either come back to you or go to the seller depending on why the deal died.
Why Sellers Ask for One
When a seller accepts your offer, they take the home off the market, turn away other buyers, and wait while you handle inspections and financing. A good faith deposit compensates them for that risk. It signals you have something to lose if you walk away for no reason.
The deposit isn’t a payment for the property. It’s a pledge against your performance under the contract. Complete the purchase and the money gets folded into your closing costs or down payment. Walk away for a reason the contract doesn’t protect, and the seller keeps it.
How Much to Put Down
On a resale home, 1% to 3% of the purchase price is the standard range. On a $400,000 home, that’s $4,000 to $12,000. The exact number is negotiable and shaped by local conditions.
In a hot market with multiple offers, a larger deposit signals stronger commitment and can help your offer stand out. In a slower market, sellers have less leverage to push for a big deposit. Most places set no legal minimum or maximum; the amount is whatever both sides write into the contract.
New construction works differently. Builders often set a fixed deposit rather than negotiating a percentage, and the money is sometimes held by the builder rather than a third-party escrow agent. Many of the standard contingencies that protect resale buyers don’t apply, since the home has to pass local building code inspections and typically ships with a limited warranty.
Where the Money Sits
Your deposit almost never goes straight to the seller. That would leave you exposed if the deal fell apart. It goes into an escrow account managed by a neutral third party, usually a title company, a licensed escrow agent, or a real estate broker’s trust account.
Whoever holds the funds has a legal duty to keep them separate from their own operating money. State real estate regulators set rules about how quickly the deposit must be placed into escrow, how the account is maintained, and when funds can be released. The escrow holder answers to both sides and can only disburse the money according to the purchase agreement or a signed release from the parties.
Contingencies That Let You Get It Back
Contingencies are conditions written into the purchase contract that let you cancel and keep your deposit if something specific goes wrong. They are your main protection. Without them, backing out for any reason means forfeiting the money.
The three most common in residential real estate:
- Inspection contingency. If an inspector finds serious problems and the seller won’t repair them or adjust the price, you can cancel and get your deposit back. Some contracts cap this by setting a dollar threshold, so only repair estimates above that amount trigger the contingency.
- Financing contingency. If you can’t secure mortgage approval by the deadline, this lets you walk away with your deposit intact. It protects you when a lender denies your loan or can’t offer workable terms.
- Appraisal contingency. If the home appraises below the agreed price, you can renegotiate or cancel. Without it, you’d need to cover the gap out of pocket, since lenders won’t finance more than the appraised value.
Others show up too. A title contingency protects you if a title search turns up liens, ownership disputes, or other legal problems. A home sale contingency makes your purchase conditional on selling your current home first. Every contingency has a deadline, and missing the deadline can void the protection even when the underlying problem is real.
When You Lose the Deposit
Forfeiture happens when you default without a valid contingency to fall back on. The classic case: the inspection period passes, financing is locked in, and then you change your mind. At that point, the seller is entitled to keep the money.
Most purchase agreements treat the forfeited deposit as liquidated damages. The seller accepts the deposit as agreed compensation for the breach rather than suing for additional losses. Courts generally enforce these clauses when the amount is a reasonable estimate of the seller’s actual harm, like lost market time, carrying costs, and missed offers. A deposit wildly out of proportion to those damages could be challenged as an unenforceable penalty, but that’s uncommon within the usual 1% to 3% range.
The reverse works too. If the seller fails to perform, whether by being unable to deliver clear title or backing out on their own, you get a full refund.
Waiving Contingencies to Win a Bidding War
When bidding wars heat up, some buyers waive contingencies to strengthen their offer. This is one of the riskiest moves in real estate.
Waive the financing contingency and a mortgage that falls through costs you the deposit, with the seller potentially able to pursue additional damages. Waive the appraisal contingency and you’re on the hook for the gap if the home appraises below your offer. On a $500,000 offer that appraises at $470,000, that’s $30,000 out of pocket. Waive the inspection contingency and you’re buying as-is, so a cracked foundation or failing electrical system becomes your bill.
Every waived contingency shifts risk from the seller to you. If you’re considering it, at minimum get a pre-inspection before making the offer, and make sure your finances can absorb the worst-case scenario.
What Happens at Closing
In a successful sale, the deposit isn’t extra money out of your pocket. It gets credited toward your down payment and closing costs at settlement. If you owe $40,000 in combined down payment and closing costs and your deposit was $8,000, you bring $32,000 to the table. The escrow agent releases the funds as part of the final settlement.
How It Differs From a Down Payment or Security Deposit
These three get confused constantly. They aren’t the same thing.
A good faith deposit is made when you sign the purchase contract, weeks or months before closing. Its purpose is to show commitment. A down payment is the portion of the purchase price you actually pay at closing, representing your equity stake in the property. In a successful sale, the earnest money folds into the down payment, which is why the terms get mixed up. But the down payment isn’t at risk in the same way, because by the time you pay it, the deal is closing.
A security deposit is unrelated. Landlords collect it to cover potential damage or unpaid rent during a lease. Most states cap the amount by law, and landlords must return the deposit within a set number of days after the tenant moves out, minus documented deductions. Good faith deposits have no statutory caps and are governed by the purchase contract, not landlord-tenant law.
Watch for Wire Fraud
Earnest money deposits are a prime target for wire fraud, and the scam is more sophisticated than most buyers expect. Hackers compromise email accounts at real estate agencies, title companies, or lenders, then watch for upcoming closings. As closing approaches, they send the buyer an email that looks like it’s from the title company, with “updated” wiring instructions pointing to the hacker’s account.
Once the money goes to a fraudulent account, recovery is extremely difficult. Never follow wiring instructions sent by email alone. Verify account details by calling the title company at a number you looked up independently, not one from the email. Be suspicious of any last-minute change to wire instructions. If you suspect fraud, contact your bank immediately and request a wire recall.
Deposits Outside Real Estate
Good faith deposits aren’t limited to home purchases. Car dealerships sometimes require one to hold a vehicle while your financing is processed. The FTC’s Cooling-Off Rule, which lets consumers cancel certain purchases within three days for a full refund, does not apply to vehicles bought at a dealership or any sale negotiated at the seller’s permanent place of business.1Federal Trade Commission. Buyers Remorse: The FTCs Cooling-Off Rule May Help Whether a car deposit is refundable depends entirely on the dealership’s policy and what you signed.
In commercial transactions, deposits work similarly. A buyer might put money down to hold equipment, secure a business acquisition, or lock in terms during due diligence. Amounts and refund conditions are almost entirely governed by the contract between the parties, with far less standardization than residential real estate.
Tax Treatment of a Forfeited Deposit
Lose your earnest money on a personal home purchase and you can’t deduct the loss. The IRS treats it as a nondeductible personal expense.
The rules differ for investment or rental property. If you forfeit a deposit on a property you intended to hold as a rental or business asset, you can report the loss as a capital loss on Schedule D. The cost basis is what you deposited, the sale price is zero, and the loss is short-term or long-term depending on whether the money sat in escrow for less than or more than a year. Capital losses can offset capital gains and, if losses exceed gains, up to $3,000 of ordinary income per year, with the rest carrying forward.