Earnest Money Deposit

What is Earnest Money

Earnest money is a deposit made to a seller, as a buyer’s affirmation in good faith to buy a home. This is done for the buyer to get extra time to get financing and conduct the title search, property appraisal and inspections before closing. Usually, earnest money is handed down when the sales contract or purchase agreement is signed, but sometimes it is also attached to the offer. Once deposit is done, the funds are held in a security account until the closing, after which the deposit goes to the buyer’s down payment and closing costs. The sellers usually demand 1% – 5% of the price of the house.

Earnest money is commonly known as an ‘Escrow deposit’ or ‘Good faith money’.

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Reasons to Pay Earnest Money

A contract is signed, when a buyer decides to purchase a home from a seller. As per the contract, the buyer is under no obligation to purchase the home, as he would wait for the inspection and appraisal of the said property first. In the meantime, the contracts also ensure that the seller takes the house off the market while it’s inspected and appraised. Here, the buyer’s offer to purchase the property is made in good faith, for which he makes an earnest money deposit (EMD).

When Earnest Money Is Refundable

The buyer may recover the earnest money if everything aforementioned under the contract doesn’t fall in place. For e.g. if the house for the sale, fails the inspection and appraisal and reveals a serious defect. You have to make sure that these contingencies are listed in the contract. The contingencies arising could be –

• Unable to get financing
• Home fails inspection
• Issues with Title search
• Not able to appraise house

Of course, earnest money isn’t always refundable. For e.g.

• A seller would keep the earnest money if the buyer decides not to go through with the purchase for contingencies not listed in the contract, or
• The buyer is unable to meet the timeline mentioned in the contract. Or if the purchaser has a change of heart and decides not to buy, then the buyer will forfeit the earnest money deposit.

Earnest money is always returned to the buyer if the seller break off the deal.

Additional Reading: An Ideal Investment in Fixed Deposit

How Much You Pay in Earnest Money

While the buyer and seller can negotiate the earnest money deposit, it often ranges between 1% – 5% of the price of the house, depending on the market scenario.

Apart from the local market rates, the size of the earnest money deposit also depends on the level of interest other buyers show for the property, how much in demand the housing market is and also how quickly a prospective buyer can close on their offering price.

While the earnest money deposit is often a percentage of the sales price, some sellers prefer a fixed amount. So, higher the earnest money, the more serious the seller interests. Hence, the buyer should offer a higher earnest deposit to be accepted, without putting any extra money at risk, as there still might be a chance for the deal to not fall through or the deposit forfeited.

Earnest money is usually paid and held in an escrow account that is handled by a real estate brokerage, legal firm or title company. The funds are held in the account like a bank account until the closing, where they are applied with the buyer’s down payment and closing costs, hence they earn interest as well.

Protecting Your Earnest Money Deposit

As a buyer, you can do several things to protect your earnest money deposits.

1. Make sure contingencies for financing and inspections are included in the contract. If these aren’t present, the deposit could be forfeited if the buyer is unable to get financing or a serious defect is found during the inspection.
2. Carefully go through each terms of the contract. For e.g. Any deadlines stated in the contract, like the home inspection, it must be completed by a certain date, or you would risk losing the deposit and the house.
3. The deposit should be handled carefully. It should be payable to a reputable third party, such as an escrow company, any reputed real estate brokerage firm, a title company or a legal firm. Money should never be given directly to the seller to deposit. Upon payment, the buyer should always take a receipt and also verify that the funds will be held in an escrow account.

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