What is an earnest money deposit?
The earnest money deposit is the "good faith" deposit the buyer makes to show the seller s/he is serious about buying the home. This is in addition to the money needed for the down payment and closing costs. The earnest money deposit, often referred to as the "EMD", is usually made in the form of a personal check, but may at times need to be certified funds. The check is often made out to the title company who will deposit the earnest money check in an escrow account, although sometimes the check may be held by the buyer's broker. It should never be held by the seller! The earnest money deposit amount will be a credit towards the buyer's closing costs or down payment on the settlement statement.
How much earnest money is enough?
This is a question I hear quite frequently and not always from first time home buyers. There are no rules about how much earnest money deposit a buyer needs to make with an offer. In the Washington DC Metro area an acceptable amount is between 1-5%, but could be more, depending on the situation. For example, if the offer is being made on a $300,000 short sale, the buyer may only want to put down a small amount ($1,000) since the funds may be tied up for quite some time waiting on approval. On the other hand, if a 
buyer is making an offer on a "hot" property, s/he may want to deposit as much as 10% of the sales price to make the offer more competitive and come across as a serious buyer. In the end, the amount of earnest money is negotiable between the buyer and seller.
At the time of writing an offer, the buyer's real estate agent will ask for the earnest money deposit check. The agent must submit a copy of the check along with the offer. Once the offer is ratified, the buyer's agent will submit the check for deposit per the contract, so the buyer needs to make sure s/he has enough money in the account to cover the check. If the offer is rejected, the check will be returned to the buyer. Please note earnest money deposits may be handled differently in your state. Your real estate agent can answer any questions.
What happens if the deal falls through?
The GCAAR Regional Sales Contract (paragraph #23) and MAR Residential Contract of Sale (paragraph #33) used in Maryland, Washington DC explain default on the part of both the buyer and seller. If the buyer defaults, the seller will want to retain the earnest money deposit. However, the buyer and seller must still sign a mutual release agreement in order for the escrow agent to return the funds to the agreed upon party. If the contract falls through as a result of a contingency, such as a home inspection or appraisal, the buyer should be able to get her/his deposit back. But again, a mutual release must still be signed by both parties in order to disburse the funds. This is explained in the addenda for the home inspection and appraisal. In cases where the parties cannot agree how the deposit should be disbursed it may be necessary to involve a mediator or attorney. If at any time a buyer has questions about what constitutes default, s/he should contact their agent and/or an attorney.
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