Question: What is the point of an Earnest Money Deposit (EMD)? How much should it be?
EMD is Insurance For Seller, Strength For Buyer
An Earnest Money Deposit (EMD) represents strength of offer for the buyer and insurance for a seller that the buyer will not walk away from a deal, outside of any legal means of voiding a contract (contingencies such as the Home Inspection and Condo/HOA document review). It’s a negotiable sum of money deposited by the buyer into an escrow account after the contract is finalized, usually within 3-5 days. If the buyer walks away from the deal outside of legal means/contingencies, the seller can keep the entire sum of money as damages.
The administrator of the escrow account is also a negotiable term of the sales contract, but in most cases, it’s the same company that’s handling the title check and settlement duties, but it’s also common to see the money held by the Buyer Agent’s broker. There are very strict rules governing the administration of EMD money to prevent co-mingling of funds or conflicts of interest.
A sufficient EMD shows that the buyer is serious by giving the seller security that you’re not going to walk away from the deal and because you’re financially capable of transferring that money shortly after the contract is ratified. In most cases I recommend that buyers make, and sellers expect, an EMD equal to 2-3% of the sales price. Anything under 1% is cause for concern. The exception to this is with builders (new construction), who generally expect 5-10% EMD.
At settlement (the day you purchase the home), the EMD is credited against your closing costs and down payment. If the EMD exceeds the sum of these amounts, you’ll get the rest back.
To help explain the value of a strong EMD deposit, imagine a scenario of a buyer purchasing a $500,000 home with a $1,000 EMD. The home inspection has concluded, appraisal sufficient, and loan approved so everything is ready for settlement. Five days before settlement, the buyer sees the perfect home go on sale for a great price and decides he’d rather buy that one. With no contingencies left to legally exit the deal, he decides that losing $1,000 is worth voiding the current deal and pursuing the new home. Had the EMD been a more appropriate 2-3%/$10-$15,000, the buyer is likely to stick with his current contract and even if he doesn’t, at least the seller receives a payout likely to offset the pain of losing the contract.
Note: This is EMD in theory. In practice, everything is circumstantial. Sellers often agree to release the full or partial EMD to a buyer who walks, but can also sue for damages in addition to the EMD in certain cases where they’re unable to contract for the same sales price or better.
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