An earnest money deposit (EMD) in real estate is money that you put down with a contract. It is good a good faith deposit that shows the seller you are serious about closing the transaction. This is an important gesture from the buyer that will make the home sale process smoother.
- Sellers ask for good faith deposits to ensure buyers are serious before they take their house off the market
- Third-party escrow companies hold the funds
- It is refundable to the buyer only with cause (a contingency in the contract)
- The funds are applied to the closing costs/down payment at closing
Make sure that you create a proper paper trail for these funds. Never give a check directly to the seller, only deal with licensed escrow companies, and always get a receipt.1
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Why do sellers ask for EMD?
Sellers ask for earnest money to ensure the buyer is serious about the property. The seller has a lot at stake once they accept the deal.
- They the home off the market once they sign a contract
- If the deal falls through the seller must put the house back on the market, losing time and often money
- The buyer won’t put multiple offers on different houses if they put a good faith deposit on each property
They want to know that the buyer won’t get cold feet or find another property while they go through the lengthy process of closing the transaction.2
Typical EMD in Real Estate
A typical earnest money deposit is 1% – 5%, but how much you put down depends on several factors.
- You may have to put a higher good faith deposit on a house with multiple offers, while you won’t have to put much down on a house in a cold market
- It depends largely on state and local laws, as well as local customs.
- Most places don’t have guidelines, but California actually does require the buyer to put down a good faith deposit
- It is more important to some sellers than to others
- In some very hot markets, you may have to put as much as 10%
- For very high-priced houses you should expect to put more than $100,000.
As you can see many factors play into the decision of how much to put down with the contract. A good realtor will help you make a proper decision for your house and your area.3
Negotiate EMD
You can negotiate a good faith deposit. While some areas, like California, require some money and other areas like Colorado list minimums sellers will accept, the amount is still fluid.
- Any aspect of the contract is negotiable before you sign
- Market forces dictate many of the terms for how much you need to put down
Never be afraid to negotiate. Be mindful of your situation and respectful toward the seller, though. Above all, find a good realtor and listen to them. If you negotiate ethically, there is no reason you shouldn’t try for the best terms you can get.
Buy a Home Without EMD
You can buy a house without earnest money in most areas. In California, it is a law that you must put some down. In most areas, it depends on the market.
- For almost all transactions you will put down some.
- Unless the market is very week sellers have the leverage to require it
While you may be able to enter a contract without it you should count on having to put a good faith deposit on the property. Beyond that, even if you can leverage not having to, it will make the seller feel better about the deal. The goodwill with the seller is usually worth putting in some capital.
Who Keeps EMD in Real Estate
A third-party escrow company keeps the money.
- Never hand it directly to the seller
- Make sure the escrow company is licensed and has a good reputation
- Make sure they hold the funds in a trust account, separate from other accounts
The company must be neutral, working for neither the buyer nor seller. They hold the funds until the sale closes or until there is a determination about who should get the money.
EMD in Real Estate Cashed
In a sense, the check does get cashed, but an escrow company keeps the funds. Until a legal determination is made:
- The seller can’t take the money
- The buyer can’t retrieve the money
- Realtors can’t access the funds
- Attorneys and title companies can’t arbitrarily take any funds out of the account
All of that said, the industry goes to great lengths to protect earnest money. You can be confident that your capital is secure during the due diligence period of the process.
How Long to Deposit EMD
You do not have very many days to deposit earnest money. It is due when the seller signs the contract
- You should have a reasonable amount in your account for it while you are looking for a house
- Be prepared to hand a check to your attorney or title agency when you submit an offer
- Beyond a couple of days is too long
Not putting earnest money in an escrow account immediately gets you off on the wrong foot with the seller right from the start. You want the relationship to be good throughout the process and funding the escrow account is a big deal. If you don’t immediately deliver a check to your attorney/title company then you lose the seller’s trust immediately.4
EMD Holding a House
The EMD does not hold the house for any time period. You present a good faith deposit so the seller will sign the contract. The contract holds the seller in the agreement until the deal closes or both sides cancel it.
EMD and For Sale by Owner
When you buy a for sale by owner property a third-party escrow company still holds the funds. Even if you don’t work with a realtor you still:
- Work with a(n) attorney/title company
- Never give a check directly to the seller for anything
Even if you are working with a realtor often you will give checks directly to your attorney or title company.
EMD in Real Estate Refundable
Earnest money is refundable under certain conditions. You cannot just walk away from a signed contract without penalties, but there are contingencies that protect you from a bad investment. Remember that:
- These funds protect the seller from a buyer walking away without cause
- Contingencies protect the buyer from making a bad purchase
Unexpected or hidden problems are grounds for canceling the deal and getting your money back. Personality conflicts, finding another house, or cold feet are not good reasons, and you will forfeit your earnest money if you walk away without cause.5
EMD if Inspection Fails
You do not lose earnest money if the inspection fails and the parties can’t agree on new terms. If there is a problem with the inspection:
- It does not necessarily mean the deal is dead; you can renegotiate
- Make sure you read your contract and understand exactly what the home inspection contingency states
While home inspection issues often void contracts, the language of the contingency may give the seller an opportunity to fix the problem. If that is the case, you can’t just terminate it and walk away, you must give the seller an opportunity to address the problem.
EMD when Financing Falls Through
Most of the time you will not lose earnest money if financing falls through. Again, this is another common contingency in contracts. Just like with inspection contingencies, though, make sure you understand your contract. Read this contingency carefully to find out if you may lose any of your funds if you can’t get financing.
when can Seller Keep Earnest Money?
The seller can keep earnest money when the buyer breaches the contract. When the buyer walks away from the agreement without cause the seller has a claim to the good faith deposit.
- Contingencies allow cause for many issues protecting the buyer
- Even without cause, it may be difficult for the seller to claim the funds
Escrow companies won’t release funds without mutual consent or legal direction. If you find yourself in a legal battle lawyer fees, your time, and your frustration may make you decide it’s not worth the effort to secure the money.
EMD in Real Estate at Closing
At closing, the earnest money is put toward the cash to close, which includes closing costs and/or down payment on the house.
- It is a deposit toward the purchase of the home
- All money is always accounted for
It seems like there are endless fees associated with buying a house. Some are sunk costs, like inspection fees, title search fees, and appraisal fees. Any deposits though get credited toward the purchase. You will see exactly how the money is credited on the ledger, whether to closing costs or toward the down payment.
