For anyone who has ever bought a home, you are probably familiar with what an Earnest Money Deposit (EMD) is. For those who have yet to buy a home or are currently looking for a home, you may not have come across this term yet. In today’s post, we will look at what an earnest money deposit is and what it is used for. We will also look at what happens to this money if the sale does or does not go through.
What is an Earnest Money Deposit?
An earnest money deposit is money that a potential homebuyer deposits to Escrow to show their good faith in the transaction. Other terms for earnest money deposit include earnest money, EMD, good faith deposit or simply just deposit. In most real estate transactions in Ventura County, this deposit is given to an escrow company instead of directly to the seller. This way, the escrow company acts as a neutral third party who will either eventually use the money towards closing costs and/or the Buyer’s down payment or give the money back to the homebuyer. We will get into this later on in the post. In theory, the earnest money can be any amount that both parties agree on. For traditional sales in Ventura County, the typical EMD amount is anywhere from 1%-3%. If you are buying a For Sale by Owner (FSBO) or other off-market property, the EMD amount can be anywhere from $0.01 to the full purchase price amount. Everything being equal, a higher EMD could help get your offer accepted in a multiple offer situation. Not only does this show that you have more cash available for the purchase and are serious about the purchase, but the seller may be thinking that there is a chance they will get to keep the money if the buyer does not fulfill their end of the contract.
What happens to the Earnest Money?
Once the earnest money is deposited, there are 3 possible outcomes that will occur. The first 2 are the most common occurrences and happen a vast majority of the time.
- If the sale goes through, the earnest money deposit is used towards the purchase of the home. For instance, if you put down $20,000 as an earnest money deposit and your closing costs come out to $40,000, you would only be required to come up with $20,000 more at closing, as your EMD would be applied to your closing costs and/or down payment if a loan is being secured. If your EMD is higher than the amount needed to close, the additional amount can be applied as part of your down payment or returned to the Purchaser.
- If the sale does not go through and the buyer or seller cancels the purchase in accordance with their contract, the full amount of the earnest money deposit is returned to the buyer.
- If the sale does not go through and the buyer cancels the purchase in a manner that is not in accordance with their contract, the seller is entitled to the full amount of the earnest money and has the right to keep it if they so choose.
In your purchase agreement, the buyer can add language that gives them a certain amount of time to legally cancel the contract and receive their EMD back. In my opinion, this is one of the most important pieces of the purchase agreement.
When there are contingencies in your purchase agreement, this is stating that the purchase of the home is contingent on those items happening. If any of those items do not happen in the period specified, the buyer can legally walk away from the contract with all of their earnest money or the seller can cancel the agreement. Both of these scenarios have specific steps that must be followed. Technically, there can be contingencies for anything you can think of. In reality, there are only a few that you will find in most purchase agreements. Here are a few of the most common that you will come across.
An inspection contingency gives the buyer a certain amount of days to do a thorough inspection of the home. When you are viewing a home for the first time, most buyers are only looking at the home to ensure that it will fit their needs. Once you have an accepted offer on that property, you want to make sure you find out if there is anything physically, structurally or even just something you can’t see wrong with the home. This is where the inspection contingency comes in. In Ventura County, the standard inspection period is 17 days. This means that you have that number of days to perform your inspection and then ask the seller to conduct any repairs that you may find or walk away from the property if you find something that you do not like. It is usually a good idea to hire a professional inspector who will inspect and test all of the major systems of the home (HVAC, electrical, plumbing, etc.).
The appraisal contingency allows the buyer to walk away from the purchase if the home does not appraise for the right value. Even if the buyer has perfect credit history and their file is as clean as can be, lenders usually won’t loan more than the appraised value of the home. If the appraised value is lower than the requested loan amount, the buyer would have to pay that difference with money out of their pocket. If they do not have the necessary funds to do so, this is where the appraisal contingency can take place and the Buyer can cancel the purchase or renegotiate the purchase price to the appraised value.
Much like the Appraisal Contingency, the loan contingency allows the buyer to back out of the contract if they are unable to obtain a loan to purchase the home. Most sellers now-a-days are requesting that a written pre-approval be submitted with any offers to help alleviate this contingency coming into play. While this is helpful, this does not guarantee that the loan will actually go through. If the lender rejects your loan application for whatever reason, the financing contingency allows the buyer to get their earnest money deposit back.