What it is:
Earnest money is a good faith deposit, typically on a house purchase. It is not the same as a down payment.
How it works (Example):
For example, let's assume John wants to buy a home that is listed for $500,000. To show that he is serious and ready to close the deal quickly, he provides $10,000 in earnest money. When the deal closes, the $10,000 is applied toward the sale price (meaning that John does not pay the earnest money on top of the price of the house; he simply fronts the money).
It is important to note that the buyer does not give the earnest money to the seller. The buyer gives the earnest money to a third party, like a real estate broker, real estate attorney, escrow company, or title company, and he gets a receipt. The third party should not release the earnest money to the seller until the transaction closes, meaning that if the deal falls through, John will most likely get his earnest money back (though this varies by state and often depends on who cancels the deal).
Why it Matters:
Earnest money is little more than a way for a buyer to prove his or her sincerity to a seller. There is usually no set requirement on earnest money when it comes to home buying; local customs and the state of the market typically dictate the amount.