Getting ready to shop for a home? An important part of the home buying process is making an earnest money deposit, or “EMD.”
Also known as a “good faith deposit,” earnest money is a lump sum of cash that you plunk down when you enter into a purchase agreement with a home seller. The deposit serves as a sign of commitment and a gesture of goodwill, since you could be required to forfeit your deposit if you try to back out of the deal without a valid reason.
“Essentially, it proves to the seller that you have skin in the game,” says Seth Lejeune, a real estate agent in Blue Bell, PA. Assuming all goes well, the earnest money gets applied to your down payment or closing costs at settlement.
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Let’s take a closer look at earnest money deposits by answering some frequently asked questions.
Where is earnest money held?
Typically, you write a check for the earnest money shortly after your offer is accepted. Then the check is cashed and held in an escrow account by a neutral third party, such as a title company, a real estate brokerage, or an attorney.
Placing the money in escrow ensures that it remains safe and impartially managed until the sale is finalized or terminated.
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Why do sellers require an earnest money deposit?
Most sellers will only accept an offer that comes with an earnest money deposit, and for good reason: It provides them with financial security should you back out without a valid reason, providing compensation for the time that their property was off the market.
What's a typical earnest money deposit?
On average, you can expect to fork over 1% to 2% of a home's purchase price for your earnest money deposit. For a $300,000 house, that’s $3,000 to $6,000.
However, in today’s uber-competitive housing market, where home supply has shriveled to near record lows, making a larger deposit could strengthen your offer, Lejeune says. “Lately I’ve been encouraging buyers to put down a 5% to 6% deposit, and we point that out to the seller to make our bid more competitive,” he says.
What happens to the earnest money?
The fate of your earnest money deposit can vary depending on several outcomes:
A smooth transaction: If the deal proceeds according to plan and you close on time, the earnest money gets applied toward your down payment or closing costs.
A failed contingency: Real estate contracts often include contingencies that allow the buyer to back out of the deal under certain conditions, such as a failed home inspection, a low appraisal, or the inability to secure financing. If a contract contingency is not met, you get your earnest money back and walk away from the deal scot-free.
The seller fails to fulfill obligations or walks for no reason: You typically get your earnest money back if the seller fails to fulfill their obligations specified in the sales contract or if the seller changes their mind and tries to terminate the contract without a valid reason.
You get cold feet. If you decide to back out of the purchase without a valid reason as defined in the purchase agreement, the seller may be entitled to your earnest money deposit.
There’s an earnest money dispute. If the deal falls through and a disagreement arises over who is entitled to the earnest money, the neutral entity that’s holding the funds cannot unilaterally decide to release the money to any one particular party. “Every state has its own laws around earnest money deposit disputes,” Lejeune says. “In Pennsylvania, there is an arbitration and mediation process that has to take place.”
Lejeune’s advice: “Buyers and sellers should look at the terms around the earnest money deposit in their purchase agreement and what mechanisms are in place if either party defaults.”
How do you get more information?
If you have questions about how earnest money deposits are handled in your state, consider consulting a local real estate attorney. You can find one by using the American Bar Association’s directory or by asking your real estate agent for a recommendation. Most real estate lawyers charge $150 to $350 per hour, according to Law Guideline, a legal advice website.
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