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What is an earnest money deposit?
When a homebuyer makes an offer on a home that’s for sale, and the seller accepts the offer, a contract is signed between the two parties.
An Earnest Money Deposit (EMD), also known as a “good faith deposit,” is an amount of money that the homebuyer gives when signing a sale contract on the home or property they wish to buy. When you make a good faith deposit, you are letting the seller know you are serious about purchasing their property.
The Real Estate Purchase Agreement (also know as “the contract”) will state specific terms for how this deposit money will be held and by whom. It will also state the conditions upon which the earnest money can be refunded. In this way, the EMD protects home sellers from potential homebuyers who for, whatever reason, drop out of the buying process after their offer has already been accepted.
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Read on to learn more about the good faith deposit and the earnest money deposit in real estate.
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Is an earnest money deposit necessary?
An earnest money deposit is not required by law, nor is it truly necessary. However, it is customary for a homebuyer to make an earnest money deposit when the seller has accepted the buyer’s offer on the property that’s for sale. As we mentioned, the deposit signifies that the buyer is serious about the purchase.
The earnest money deposit, or good faith deposit, can protect the home seller in the event that the buyer walks away from the deal and the seller has to re-list the property and make up for lost time and effort to sell the home.
How much should an earnest money deposit be?
An earnest money deposit is typically between 1% and 3% of the purchase price of the property. The amount can vary based on what is customary in the city or area where the property is located.
When is the earnest money deposit made?
The earnest money deposit is paid after the buyer's offer has been accepted by the seller, and the buyer has signed the Real Estate Purchase Agreement (sale contract). The payment of the good faith deposit is usually expected no more than three days after the offer is accepted.
Earnest money can be paid by personal check, certified check, or wire transfer. The money may be held in an escrow account of a title company, lawyer, bank, or the seller’s real estate agent.
Is the earnest money deposit refundable?
There are several situations in which the earnest money deposit can be refunded, and these conditions or contingencies should be stated in the contract so both the buyer and seller fully understand the terms of the agreement they are entering.
If the buyer no longer wants to purchase the home, and the reason is not covered by any of the contingencies stated in the contract, then the buyer could lose the deposit.
Understanding contingencies
Contingencies are certain circ*mstances which, if they occur, will be acceptable as reasons for refunding the earnest money deposit. They are:
Home inspection contingency. All homebuyers should order an inspection of the home they are in contract to purchase. An inspection contingency allows the buyer to withdraw from the contract and be refunded their earnest money if during the inspection the home is found to have major defects that would prevent the buyer from getting a mortgage. Most lenders will not provide a loan if a home has significant structural defects.
Appraisal contingency. Earnest money may be refunded if the house doesn’t appraise for more than the purchase price, thus affecting the ability of the buyer to get a mortgage.
Financing contingency. If the buyer, in good faith, applies for a mortgage but is turned down, the earnest money can be refunded.
Contingency for selling your home. If the buyer must sell their home to have enough money to complete the purchase of another home, this is a contingency. If you are not able to sell your home in a timeframe agreed to by the seller of the home you wish to purchase, you may be refunded your deposit.
Is it possible to lose your earnest money deposit?
Yes, these are some situations that could result in the buyer losing their good faith deposit:
Waiving your contingencies. In some cases, the buyer may waive contingencies, meaning you would give up the right to be refunded your good faith deposit, should any of the above contingency scenarios take place. For example, if you waive the inspection contingency and later find out that the house has termite infestation, you would either lose your deposit or proceed with the home purchase anyway.
Losing track of timelines. The process of buying and selling a home follows a pretty tight schedule, especially if there’s a mortgage involved and the buyer is also selling a home. If certain milestones in the process are missed, such as getting an appraisal in a timely manner, the seller could seek to keep the earnest money deposit and relist the home for sale.
Protecting your good faith deposit
Always protect your earnest money deposit. Start by getting a receipt for the funds and knowing exactly who is holding the money. Here are other ways to protect your deposit:
- Hold the money in an escrow account. This is the best way to protect your money. An escrow company or a title company will also help set up the closing and hold your funds safe in the interim.
- Keep track of the timeline. If you are working with a real estate agent, he or she can help you stay on track.
- Have all terms in writing. If you give an earnest money deposit be sure to get a receipt, a copy of the contract, and information on who is holding the money.
What is the earnest money deposit used for?
Assuming the sale of the home is moving forward for both the buyer and the seller, the earnest money won’t be refunded at closing. It will go toward paying down other costs associated with your purchase. Typically, the funds are applied to the buyer’s down payment and closing costs.
Before making the earnest money deposit
Before making an earnest money deposit, you should be sure you are truly interested in purchasing the home in question. If you have any uncertainty, then it’s better to not give an earnest money deposit and continue to look for a home that you are confident you want to buy. There's always a possibility that you could lose the deposit if conditions arise that are not covered for any of the reasons discussed above.
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