Earnest money is a small sum which is paid when a contract for a purchase is signed, to indicate that the buyer is serious about following through on the contract. Earnest money is also sometimes called a deposit or good faith deposit. Most commonly, the topic of earnest money comes up in real estate transactions, although it could potentially be used in other types of contracts as well. It is not the same thing as a down payment, although it is often included as part of the down payment.

In a classic example of the way in which earnest money is used, Party A agrees to buy a house from Party B. The two parties work out the purchase price, and they agree on a contract and sign it together. At the signing, Party A provides a payment of earnest money which is held by a broker. Once all of the financing and other issues have been dealt with, the earnest money is bundled into the down payment, and Party A takes possession of the house.

From a buyer's point of view, earnest money along with a contract indicates that he or she really does intend to buy the house. Once a contract has been signed, the seller isn't supposed to sell the house to someone else, but the seller might back out if a better deal comes up, being willing to risk potential penalties. With earnest money, backing out becomes harder, making the purchase a done deal for the buyer. For sellers, earnest money is a form of insurance, because most people are unwilling to walk away from their earnest money payment, so they will think twice about reneging on the deal.

The amount of earnest money required varies, and is generally worked out in the contract. In some communities, people exchange a dollar, or a similarly low unit of currency, as a symbolic act. In other instances, people may put up as much as three percent of the value of the contract. In all cases, the terms surrounding the earnest money are spelled out in the contract, and it is a good idea to find out what happens to the earnest money if the deal falls through. Buyers, for example, might want a refund clause in the event that they cannot get financing, while sellers may desire a forfeit clause so that if buyers walk away for a petty reason, the seller gets the earnest money in compensation.

Earnest money is usually handled by a real estate agent or broker. It should never be paid over to the seller or to an unreliable third party. Real estate agents are usually happy to handle earnest money payments or to refer their clients to a reputable broker, and a receipt for the money should always be obtained. Buyers and sellers alike may want to be aware that money can potentially sit in escrow for a long time if the deal falls apart and the terms of the contract are unclear, and it may take a trip to court to release the earnest money.

In some cultures, earnest money is known as lucky money, and by tradition, the seller gives it back to the buyer when the down payment is provided. The return of the funds is supposed to provide good luck in future endeavors, and to foster good will between buyer and seller. If you are buying or selling abroad, you may want to ask a local about the custom, so that you do not inadvertently offend by violating tradition.