Earnest Money – Definition

Cite this article as:"Earnest Money – Definition," in The Business Professor, updated November 30, 2018, last accessed May 27, 2020, https://thebusinessprofessor.com/lesson/earnest-money-defined/.

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Earnest Money Definition

Earnest money is a payment made in good faith to secure a transaction. This payment is made by buyer to the seller (service provider). It is mostly made in real estate transaction. It is made to ensure that transaction will be completed at some point in the future.
If a buyer does not complete the transaction according to the underlying agreement, the earnest money will be forfeited to the seller.

A Little More on What is Earnest Money

Earnest money provides security for a contract. When buyer pays earnest money it is either retained with seller or held by a third party (escrow agent). The amount of earnest money is deducted from the amount owed at the finalization of the transaction.

The amount of earnest money varies depending upon the type of transaction and location. In some countries, it is a percentage of sale price (e.g. 5% or 10%). In some places, the amount of earnest money is fixed. In these places, buyers pay a fixed amount of earnest money at the time of contracting.

References for Earnest Money

Academic Research on Earnest Money

●      An analysis of the price formation process at a HUD auction, Allen, M., & Swisher, J. (2000). Journal of Real Estate Research20(3), 279-298. This study considers whether auctioned properties sell for different prices than they would bring through private negotiation. It also considers whether the order of sale of the auctioned properties affects observed prices.

●      An Analytical Discussion of the Promise of Sale and Related Subjects, Including Earnest Money, Smith, J. D. (1959).. La. L. Rev.20, 522.

●      Contracts as Commodities: Issues and Approaches in Regard to Commercial Real Estate Earnest Money and Option Contracts-A Texas Lawyer’s Perspective, Ellis Jr, B. J., & Abramowitz, B. I. (1984).. Mary’s LJ16, 541.

●      Guarantees for contractor’s performance and owner’s payment in China, Meng, X. (2002). Journal of Construction Engineering and Management128(3), 232-237. This paper first analyzes the problem of default risk that contractors and owners often face in China, then stresses that establishing a construction contract guarantee system is a necessary and effective measure for solving this problem. Policy choice for establishing a construction contract guarantee system in China is presented in this paper by using the experience of developed countries for reference and taking Chinese domestic circumstances into account.

●      Contracts as options: some evidence from condominium developments, Shilling, J. D., Benjamin, J. D., & Sirmans, C. F. (1985). Real Estate Economics13(2), 143-152. This paper values the real estate option to purchase contract in a contingent claims framework. The model is an application of the Black and Scholes option pricing model.

●     The Function of Earnest Money in the Civil Law of Sales, Hebert, P. M. (1930). Loy. LJ11.

●      Contracts as options: some evidence from condominium developments, Shilling, J. D., Benjamin, J. D., & Sirmans, C. F. (1985). Real Estate Economics13(2), 143-152. This paper values the real estate option to purchase contract in a contingent claims framework. The model is an application of the Black and Scholes option pricing model.

●      The economics of performance margins in futures markets, Kahl, K. H., Rutz, R. D., & Sinquefield, J. C. (1985). Journal of Futures Markets5(1), 103-112.

●      Earnest money, Dorris, M. (1992). Ploughshares18(1), 200-211.

●      On How to Distinguish and Apply Earnest Money and Deposit, Shao-hua, C. H. E. N. (2008). Journal of Wuhan Institute of Technology1, 010.

●      ” God’s Penny” as Earnest Money: The Historical Meaning of Earnest Money, Tetsumi, K. A. T. O. (2011).

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