FAQ: What is an Earnest Money Deposit and Why Do I Need to Make One?
When I work with buyers, be they first time buyers, or repeat buyers, the need for an earnest money deposit (EMD) can come as a surprise. Let's face it, most people don't run around with check books anymore.
An EMD is a check made out to the buyer agent brokerage, or title company, and accompanies the offer made by the buyer. It is money showing the buyer's good intentions to follow through on the offer they made to purchase a home. The money, when the purchase offer is accepted, is deposited into an escrow account and goes toward any closings costs or down payment due from the buyer at settlement. So if you made an EMD of $5,000 and your closing costs and down payment total $15,000, you would only have to pay $10,000 at settlement.
Buyers often don't want to make this deposit. In their hearts, they know they have every intention of following through with the transaction. If they didn't, they wouldn't be making an offer. However, there needs to be some sort of consideration for a seller to take their home off the market. This is the EMD. If you don't happen to go to settlement and default on the contract, your EMD would be liquidated to the seller. Understand, default is what happens when a buyer has passed through their inspection contingency, financing contingency, appraisal contingency and had a copy of the HOA or condo documents delivered to them for review. Some buyers may have contingencies like coinciding settlement contingencies, meaning their existing home must settle BEFORE they can purchase the next home. That type of contingency gives the buyer a right to void the contract if their existing home doesn't go to settlement. But if you have let all your contingencies lapse and then decide you don't want to buy the home, or your financing fell through because you lied to the lender about how much money you make by giving them fraudulent pay stubs, THOSE are situations in which you could lose your EMD to the seller.
There is no set amount that an EMD needs to be. However, what is customary in the Northern Virginia marketplace is about 1% of the sales price. If you are buying a $400,000 home, a $4,000 EMD would be expected. The amount of your EMD will depend on the circumstance of your offer. Not all buyers have that kind of money. Perhaps a buyer is using a VA loan and not putting any money down on the home, and the seller is going to pay their closing costs. In those cases, lower EMDs would not be unusual. However, if you are putting 20% down on a home that costs $400,000 and put down less than 1% of the sales price, there is going to be some question as to whether or not you actually have the down payment funds, or if you are serious about the purchase of the home. Or if you are in a multiple offer situation, a higher EMD can show a seller that you are more of a sure thing than another buyer. Literally, it's a way of putting your money where your mouth is.
Large EMDs show that you, as a buyer, are 100% confident that you won't default on the contract. That doesn't mean you won't void the contract on a contingency like home inspection or appraisal, if there is cause for concern. A void contract, where a buyer uses a contingency to get out of the contract, means the EMD is returned to the buyer. So you can see where a seller, looking at low EMDs would wonder what your true intentions are.
Most times, buyers have the funds they will use for an EMD in a savings account and not in their checking account. There is a transfer of funds that needs to occur. There is no need to transfer those funds until your offer is accepted, or what we call ratified. In Virginia, we had five business days to deposit your EMDs, once the contract has been ratified. The brokerage I work with wants the EMDs with two days of the date of ratification. So when I counsel buyers, I will tell them to hold off on those transfers until they get word from me that they are ratified.
If your EMD is going to be coming from a source like a TSP or 401K, well, that is a transfer you want done before you start house hunting, as they can take more than a couple of clicks on the computer to get the funds from one place to another instantaneously.
When it comes to EMDs, ask questions when talking with your real estate agent. We deal with this stuff every day. I find discussing this early in the house hunting process makes for less surprises later.