What is an Earnest Money Deposit?
For many home buyers, purchasing a home can seem quite daunting. The transaction involves a lot of paperwork, moving parts, and legal and real estate jargon being thrown around that can often feel totally foreign. Throughout the homebuying process, we get countless questions from clients as we guide them step-by-step and make sure that they are comfortable and understand the process. One of the more frequently asked questions we receive from clients and prospective home buyers is, “What is an earnest money deposit?”.
An earnest money deposit, also referred to as an EMD or just simply a deposit, is money that is given from the buyer to the seller, after having an offer accepted, to show the seller they have good faith in the transaction. The deposit demonstrates to the seller that you have “skin in the game” and are committed to the transaction. The deposit is then held in an escrow account until the transaction is closed, at which point the deposit is applied to the down payment.
As you, or your agent, writes an offer on a home, the deposit amount will need to be determined. An earnest money deposit typically amounts to 1-3% of the purchase price. The larger the deposit, the stronger the offer. The amount needed for a deposit is also somewhat determined by the local real estate market you are in. In hot markets where there is a lot of competition between buyers, it may be necessary to submit a larger deposit. Whereas in slower markets, 1% may be reasonable.
So why is a deposit necessary? To really understand why an earnest money deposit is important, think about it from a seller’s perspective. By accepting a buyer’s offer and taking their home off the market, they are no longer advertising the home and may be missing out on opportunities from other buyers.
A seller would not want to, or at least, would be much less likely, to accept an offer with no deposit because there is nothing committing that buyer to see the transaction through till the end. A buyer who is making offers with no deposit could make a bunch of offers on all different properties and just wait to see which ones get accepted and then choose from there, with no penalty or loss on their end. This would end up wasting a lot of time for those involved and would leave the seller in a position of having missed potential opportunities and needing to start from square one.
When considering the deposit in an offer, many buyers are concerned about the risks involved with a deposit. A real estate purchase agreement is a legally binding contract and does carry with it some risk. However, there are contingencies in place that help to protect the buyer and minimize the risk of losing your deposit. These contingencies are standard in most contracts and a buyer has a right to them unless they choose to waive their contingencies, which is not advisable unless you are fully aware of what you are getting yourself into.
All aspects of a contract are negotiable but a standard real estate purchase agreement (RPA) in the state of California includes a 17 day inspection contingency period and a 21 day loan contingency period. The inspection contingency period is your time to conduct all your inspections and due diligence. This is the time, as a buyer, where you conduct your general home inspection and can bring in any other specialists that you would like. If something is found during this period that changes aspects of the deal and you are not able to resolve it with the seller, this is your opportunity to back out without penalty.
The loan contingency is similar to the inspection contingency except that it is in regards to your ability to qualify for a loan. Even if you have a valid pre-approval letter, there are things that can come up that won’t allow you to qualify for a loan, therefore not have the ability to purchase the property. Should this occur within your loan contingency window, you are able to back out of the transaction with little or no penalty.
Every real estate transaction is different so to make sure that you are protected in the agreement, have your agent or an attorney review the documents. In most cases, the buyer is able to get a full refund of their deposit if something comes up during the contingency periods, or may have to pay a small cancellation fee. It is rare and only in the most extreme circumstances that the buyer forfeits their entire deposit.
The above real estate information on What is an Earnest Money Deposit? was provided by John and Melissa Steele. John and Melissa can be reached at firstname.lastname@example.org or by phone at 619-887-4429.
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