Once you have made the decision to purchase a home, and have chosen a suitable property, you might be expected to extend an earnest money deposit (EMD). This is money that demonstrates to the seller that you are serious in purchasing his or her house. It is essentially a deposit that shows your intent to act in good faith.

To clarify, the earnest money deposit is different than a down payment. In many cases, the EMD is actually part of the down payment. If you decide to back out of the purchase transaction once escrow has begun, the seller has the legal right to keep it (though laws vary by state).

In this article, we’ll provide the details behind making a good faith deposit. You’ll also learn how conflict can arise regarding its refund in the event the purchase transaction is canceled.

Size Of Your Earnest Money Deposit

Size varies by market conditions. Some experts suggest that a homebuyer should be willing to offer 3 percent of the amount stipulated in the purchase agreement. Others argue 3 percent is excessive; according to them, the EMD should be no more than 2 percent of the purchase price. Still others recommend extending a specific dollar figure (e.g. $3,000) rather than a percentage.

Confusing the matter further, a seller’s market is likely to attract larger earnest money deposits than a buyer’s market. This is understandable since competition among buyers increases in a seller’s market.

The amount you offer the seller will ultimately be dictated by state laws and market forces. If there are few buyers, and a particular seller is motivated to sell, a $500 EMD may be sufficient.

Who Receives The Deposit?

Payment can be handled in different ways. Ideally, the deposit should be given to a third party, such as a law firm or real estate brokerage. It should not be given to your real estate agent, or to the seller.

Place the EMD into an escrow account with a contract that details the circumstances under which the deposit will be released to the seller or returned to the buyer. If the purchase transaction is canceled during escrow, the contract will determine who has the right to keep the deposit.

What If Conflict Arises Regarding The Deposit’s Return?

There are countless situations in which the transaction falls through, and both buyer and seller believe they should receive the earnest money deposit. Usually, both parties are required to sign a mutual document stating what is to happen with the good faith money. In cases where both parties feel differently, the company holding the EMD will continue to do so. The money will be released when the third party receives an agreement signed by the buyer and seller, or the state’s statute of limitations is reached.

As mentioned, each state has different laws governing treatment of the EMD. For example, California requires that action is taken with three years. New York forces an action with two years.

An Example Showing Potential Conflict

Suppose after looking at homes for sale, you have chosen to purchase a particularly attractive property. You extend an offer to the seller, which she accepts. To demonstrate your intent to buy, you offer a $2,500 earnest money deposit, which is placed into an escrow account. However, during escrow, you forget to file the proper documentation with your loan application, and financing falls thorough. Consequently, you cancel the purchase. The seller believes the EMD is hers to keep. You believe the deposit should be returned to you. Thus, a conflict arises.

Normally, the contract filed with the good faith money should determine who has the right to keep it. If you and the seller disagree, however, the case can ultimately end up in court.

An earnest money deposit is a valuable way to demonstrate to a seller your intent to purchase his or her home. But realize it does not guarantee a smooth transaction. For that, many other factors must fall into place.

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Category: Real Estate
Keywords: earnest money, earnest money deposit, buying a home