What Is an Earnest Money Deposit?
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The Purpose of Earnest Money
The purpose of an earnest money deposit (also known as EMD or good faith payment) is to demonstrate the seriousness of the offer.
An EMD is typically a cash deposit from a home buyer to a home seller. It comes into play when a buyer makes an offer to purchase a home. In addition to the signed purchase agreement, the buyer gives this deposit to the seller (through the seller’s broker, closing attorney, or title company).
Without an earnest deposit, many sellers would be reluctant to take their home off the market, concerned that the buyer could easily back out of the deal.
By putting money on the line, the buyer is more likely to take the offer seriously, and if the buyer does back out for no good reason, the seller often has ground to keep the earnest money deposit.
How Much is an Earnest Money Deposit?
An earnest money deposit is typically 1% to 3% of the purchase price of the home, though it can be higher or lower in some circumstances.
The “appropriate amount” for an earnest money deposit is largely dictated by state law in some instances or the state or local customs in others. The market can also determine how much an earnest money deposit should be; the earnest deposit will generally be higher in a seller’s market and lower in a buyer’s market.
If a buyer is not sure how much of an earnest money deposit to offer, a real estate agent can be of assistance.
Who Holds the Earnest Money Deposit?
In most situations, the buyer (or the buyer’s agent) will give their earnest money deposit to the seller’s agent, closing attorney, or title company.
It’s not a good idea for a buyer to give their earnest money deposit directly to the seller because the money does not yet belong to the seller.
An earnest money deposit is typically held in an escrow account by a real estate brokerage or by the law office or title company that will be handling the closing.
Whether a law office or title company handles the closing depends on the state in which the transaction takes place. Some states require that all real estate transactions are closed by an attorney, and other allow for the use of a title company.
When and How is the Earnest Money Deposit Delivered?
The buyer can write a personal check (if allowed), cashier’s check, or can arrange for a wire transfer. This is usually done one to three days after the home goes under contract, but the earnest money deposit could accompany the offer, or it could be deposited after several days, depending on state law and customs.
What Happens to the Earnest Money Deposit?
If the transaction makes it to closing, the earnest money deposit is taken out of the escrow account and applied toward the buyer’s purchase price, down payment or closing costs. If the transaction falls apart before closing, different outcomes regarding the earnest money deposit can occur, depending on why the transaction fails to close.
How Does a Buyer Get Their Earnest Deposit Back?
When a buyer makes an offer on a home, the offer is typically made with certain contingencies. The possible contingencies are usually related to financing, inspection, appraisal, title, and sale of another home.
- With a financing contingency, the deal may be canceled if the buyer cannot get their loan approval.
- With an inspection contingency, the buyer may decide not to buy the home if major defects are found after an inspection.
- With an appraisal contingency, if the house does not appraise for the amount of the offer, the buyer can back out.
- In most cases, if there are title issues, the buyer can back out.
- When closing is contingent on the sale of another home, this is included when the buyer needs to sell their previous residence prior to purchasing the new one. If their previous home doesn’t sell within the time period specified in the purchase agreement, the buyer could back out.
Buyers can also get their earnest money back if the seller fails to abide by their terms specified in the purchase agreement.
How Can a Buyer Lose Their Earnest Money?
Buyer contingencies usually have a deadline and must be acted on during the due diligence period.
For example, if the due diligence period to get an inspection is ten days, then the decision to back out of the deal typically needs to be made within this specified period. If the buyer decides to back out after the deadline, the buyer may forfeit their earnest money deposit.
If a buyer decides they don’t want to buy the property for a reason other than a contingency issue associated with the deal (e.g. – if they’ve simply had a chance of heart), they will generally forfeit their earnest money deposit.
In some cases, a buyer might waive their right to certain contingencies. If the buyer waived the inspection contingency, for example, and then discovered the house had major problems, the buyer could still back out but would lose their earnest money deposit. Likewise, if the buyer found a better house or decided not to be a homeowner at this time, they would not have to buy the house, but they would lose their earnest money deposit.
Earnest Money Disputes
When a dispute arises over who is entitled to the earnest money deposit, it might be necessary for the parties to contact a mediator or attorney to help settle the issue. The escrow holder can guide parties on what to do in the event of a dispute.