There is a lot of terminology that you hear during the home buying process, and if you plan to purchase a home in the near future, you may have heard the term Earnest Money Deposit. If you haven’t or don’t quite know what it means, you’ll want to read on because it’s pretty important.
Most people must put some amount of money down on a home as a deposit when they submit a bid or offer for the home they want to buy. It’s typically written into the purchase agreement as an Earnest Money Deposit (EMD), or referred to as a good faith deposit, and it lets the seller know you are serious about your bid. This can also make your offer more attractive if there are multiple offers in place.
EMDs aren’t legally required, but sellers can contractually require them.
Why? Simply because they want to make sure you intend to close on the home and are willing to put money on the line, and if you back out of the deal for any reason not listed in your contract, for example you changed your mind or found a different house, the seller gets to keep the deposit.
Your Earnest Money Deposit is not the same as a down payment. An EMD can be as small as $500 to $1000. It’s deposited into an escrow account at the time you enter into a contract with the seller and will be credited as part of your down payment or closing costs at the time of closing.
A down payment can be as little as $0 in certain towns that qualify under government programs, but most buyers typically put down between 10-20% of the final purchase price of the home. This is provided at the closing and is part of the mortgage agreement with your lender.
How to lose your Earnest Money Deposit
If you cancel the purchase agreement for a valid reason, then your deposit will be returned to you. However, if you cancel for one of these reasons, you may forfeit your EDM:
- Not meeting deadlines: Your contract includes a timeline that you must follow in order to get to the closing table. Sometimes deadlines need to get shifted a little, but both parties must agree to new dates.
- Over bidding: If the inventory is tight, you might find yourself in a bidding war and feel pressured to bid higher than you feel comfortable. If you realize too late that you made an offer that was accepted but you can’t follow through with, you may lose out on that deposit.
- Agreeing to a non-refundable deposit. Make sure you read the fine print. Many bank-owned properties include non-refundable deposit verbiage to make sure buyers are serious and aren’t making quick offers to get under contract but then back out after inspections. Make sure you read the contract before signing that check.
- Waiving contingencies or not doing due diligence. In a multi-offer or hot market situation, buyers may be wary about asking for too much from the seller in order to get under contract. They can waive their right to contingencies including requesting repairs or price adjustments after a home inspection. If you find out that the home has some costly issues, you may have to sacrifice your deposit to get out of the deal.
- Realizing it’s not “The One” or finding a different house. There isn’t a clause in the purchase agreement that allows you to back out of the contract because you realize the house isn’t the right fit or you find a “better” house. If you have a change of heart after seeing the house again or seeing another house that just came on the market, you’ll most likely have to forfeit your deposit if you back out.
- Change of circumstances. Sometimes personal reasons pop up that are unforeseeable and make it impossible to continue on with a purchase. This could be a divorce, job loss, illness, etc. and while this wasn’t something that you could have planned for, the seller is under no obligation to return your deposit, although you could make a plea depending on your situation.
It’s critical that you understand your purchase agreement and all the details prior to signing it. Your Realtor should be able to explain everything to you, so you know exactly what is required from you to see the contract through to closing and what contingencies are in place to protect you and your deposit. If you need help with negotiating a purchase price after a home inspection, check out our blog. If you ever have any financing questions, we are always here to help.
Vice President, Senior Mortgage Lender
NMLS MLO ID: 532621