A good faith deposit is money a buyer puts up when signing a purchase contract to show the seller they intend to follow through. In residential real estate, where it’s usually called earnest money, the deposit typically runs between 1% and 3% of the purchase price. It sits in a neutral escrow account until the deal closes or falls apart, and then it either goes toward your closing costs, comes back to you, or is forfeited to the seller depending on why the deal ended.
The deposit is not a payment for the property. It’s a pledge against your performance under the contract. If you close, the money is credited to you. If you walk away for a reason your contract doesn’t protect, the seller keeps it.
How Much You’ll Put Down
Earnest money in residential real estate typically ranges from 1% to 3% of the sale price. On a $400,000 home, that’s $4,000 to $12,000. There is no statutory minimum or maximum in most places; the amount is negotiated and written into the purchase contract.
Market conditions drive the number more than anything else. In a competitive market with multiple offers, a larger deposit signals stronger commitment and can help your offer stand out. In a slower market, sellers tend not to push for a big deposit because they have fewer alternatives.
New construction works differently. Builders often set a fixed deposit amount instead of negotiating a percentage, and the money is sometimes held by the builder rather than a third-party escrow agent. Many of the standard buyer contingencies in resale transactions don’t apply, since the home has to pass local building code inspections and usually comes with a limited warranty.
Where the Money Sits
Your deposit almost never goes directly to the seller. Handing cash to the other side would leave you with no protection if the deal collapsed. Instead, the funds go 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 is legally required to keep them separate from their own operating money. State real estate regulators set rules on how quickly the deposit must be placed into escrow, how the account must be maintained, and when funds can be released. The escrow holder acts as a fiduciary to both sides and can only disburse the money according to the purchase agreement or a signed release from the parties.
Contingencies That Get Your Money Back
Contingencies are conditions written into the purchase contract that let you cancel and recover your deposit if something specific goes wrong. They are the main protection a buyer has. Without them, backing out means forfeiting the money.
The three most common contingencies in a residential contract:
- 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 repairs above that amount trigger the right to walk.
- Financing contingency. If you can’t secure mortgage approval by the deadline in the contract, you can cancel with your deposit intact. This covers a denial or a loan offered on terms you can’t accept.
- Appraisal contingency. If the home appraises for less than the contract price, you can renegotiate or cancel. Without it, you’d have to cover the gap in cash, because a lender won’t finance more than the appraised value.
Other contingencies show up as well. A title contingency protects you if a title search reveals liens or ownership problems. A home sale contingency makes your purchase conditional on selling your current home first. Every contingency has a deadline, and missing it can void the protection even if the underlying problem is real.
When You Lose the Deposit
You lose the deposit when you default on the contract without a valid contingency to rely on. The classic case: the inspection period has passed, your financing is locked, and then you change your mind. The seller is entitled to keep the money.
Most purchase agreements treat the forfeited deposit as liquidated damages. The seller accepts the deposit as the agreed compensation for the buyer’s breach instead of suing for additional losses. Courts generally enforce these clauses as long as the amount is a reasonable estimate of the seller’s actual harm, such as time off the market, carrying costs, and lost offers from other buyers. A deposit grossly out of proportion to those damages could be challenged as an unenforceable penalty, but that is uncommon within the typical 1% to 3% range.
The reverse applies too. If the seller defaults, say by failing to deliver clear title or walking away, you’re entitled to a full refund.
What Happens to the Deposit at Closing
In a successful transaction, the deposit isn’t an extra cost. It’s credited toward your down payment and closing costs at the settlement table. If you owe $40,000 in combined down payment and closing costs and your earnest money was $8,000, you bring $32,000 to closing. The escrow agent releases the funds as part of final settlement.
Good Faith Deposit vs. Down Payment vs. Security Deposit
Three terms that get mixed up constantly:
A good faith deposit is made when you sign the purchase contract, weeks or months before closing. Its purpose is to show you’re committed.
A down payment is the portion of the purchase price you 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 people confuse the two. 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 security deposits to cover potential damage or unpaid rent during a lease. Most states cap security deposit amounts by law and require the landlord to return the deposit within a set number of days after move-out, minus documented deductions. Good faith deposits have no statutory caps and are governed by the purchase contract, not landlord-tenant law.
Waiving Contingencies to Win a Bidding War
In competitive markets, buyers sometimes waive contingencies to make their offers more attractive. Every waived contingency shifts risk from the seller to you.
Waive the financing contingency, and if your mortgage falls through you lose your deposit and the seller could pursue additional damages for breach of contract. 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 in cash. Waive the inspection contingency, and you’re buying as-is; a cracked foundation or failing electrical system becomes your repair bill.
If you’re considering waiving contingencies, at minimum get a pre-inspection before you make the offer, and be sure your finances can absorb the worst-case outcome.
If There’s a Dispute Over the Deposit
Deposit disputes are among the messiest parts of a failed deal. Both sides claim the money, and the escrow holder has no authority to pick a side.
Most purchase agreements include a dispute resolution process. Some require mediation first. Others include binding arbitration clauses, which keep the matter out of court but still produce a final decision. If neither side gives in, the escrow holder usually retains the funds until it receives a signed release from both parties or a court order.
When the escrow agent genuinely can’t tell who should get the money, they can file an interpleader action. That’s a lawsuit in which the escrow agent deposits the funds with the court and asks a judge to decide. The escrow agent’s legal fees for filing often come out of the deposit itself, so both sides lose a slice to attorneys before anyone is paid. The process can take months, which is one more reason to make sure your contingencies and deadlines are airtight before signing.
Protecting the Deposit From Wire Fraud
Earnest money is a prime target for wire fraud. Hackers compromise email accounts at real estate agencies, title companies, or lenders, monitor upcoming transactions, and send the buyer an email that appears to come from the title company with “updated” wiring instructions pointing to the hacker’s account. Once the money is wired to a fraudulent account, recovery is extremely difficult.
A few precautions matter. Never follow wiring instructions sent by email alone. Verify account details by calling the title company at a phone number you looked up independently, not one in the email. Treat any last-minute change to wire instructions as suspicious. If you think you’ve been targeted, call 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 a deposit to hold a vehicle while 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 whatever you signed.
In commercial transactions, a good faith deposit may hold equipment, secure a business acquisition, or lock in contract terms during due diligence. Amounts and refund conditions are almost entirely governed by the contract between the parties, with far less standardization than in residential real estate.
If You Forfeit the Deposit, Can You Deduct It?
If you lose earnest money on a personal home purchase, you cannot deduct the loss. The IRS treats it as a nondeductible personal expense.
Investment and rental property are treated differently. If you forfeit a deposit on a property you intended to use as a rental or business asset, you can report the loss as a capital loss on Schedule D. Your cost basis is the amount 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 one year. Capital losses offset capital gains, and if losses exceed gains, up to $3,000 in ordinary income per year, with the remainder carrying forward.