Homebuyers and sellers often ask: “What is the EMD (Earnest Money Deposit Check)?”.
The EMD protects sellers and buyers during the sale/purchase process (transaction). Let’s explore the basics and understand how an EMD works.
Explanation of the EMD (Earnest Money Deposit Check)
What Is Earnest Money?
The Earnest Money Deposit (EMD) given to the seller demonstrates the buyer’s good faith intention to buy the home. It shows the buyer is serious about the offer to buy the home. Also, known as a good faith deposit. It proves commitment.
Earnest money gives:
- The buyer time to line up financing (mortgage);
- Perform a title search;
- Get a property appraisal; and
- Conduct inspections of the home before closing (finalizing) the transaction.
In other words, the earnest money is a deposit with an escrow company (or title company) known as “good faith money”.
Often, the sales/purchase contract requires the buyer to deliver the earnest money to an escrow company. The earnest money deposit is due with the escrow company within three days after offer acceptance. The escrow company deposits the EMD into a specified escrow account.
How Does Earnest Money Protect The Buyer?
When a buyer likes a home and wants to buy it, earnest money along with a signed purchase/sale agreement keeps the seller from selling it to someone else. Thus, the seller takes the home off the market. In addition, the earnest money deposit applies to the buyer’s closing costs as a down payment.
As mentioned above, it gives the buyer time to:
- Check out the seller’s ability to sell the home;
- Get financing;
- Hire professional inspectors to look at the condition of the home; and
- Make sure no termites or pests exist.
If any of these steps fail the buyer may cancel the purchase based on the failure of one or more contingencies. Canceling a purchase because of a contingency failing allows the buyer to get the earnest money back. We will explain the contingency below.
How Does Earnest Money Protect The Seller?
After signing a sales agreement when the buyer deposits earnest money into an escrow account it protects the seller.
Selling a property without earnest money leaves the seller vulnerable. The seller takes the home off the market while the transaction moves towards the closing. If the sale falls through the seller must put the home back on the market (re-list) and wait for another buyer. This could cause financial hardship.
This is why an earnest money deposit protects a seller from wasting time and losing money if the buyer backs out.
In addition, depositing earnest money decreases the chance of a buyer making multiple offers on homes. This prevents a buyer from tying up sellers with the ability to walk away.
The seller gets to keep the EMD if the buyer fails to complete the purchase due to a change of heart or a reason not included in the contract’s contingencies.
How Much is the Earnest Money Deposit in California?
In California, a typical earnest money deposit ranges from 1% to 3% of the purchase price.
For example, a $500,000 home earnest money deposit can range from $5,000 to $15,000. It depends, a buyer may offer $5,000 but a seller may require $10,000 or more.
It’s open for negotiation like the sales price. For instance, in a hot market, a seller may ask for a 10% EMD. In such a market, buyers may offer higher EMDs to show sellers how serious they are.
Tip for Buyers: Ask your Realtor about how much you should offer as earnest money.
Normally, the earnest money is paid by a personal check, certified check, or a bank wire transfer into the escrow company’s account. The funds remain there until the closing.
Escrow accounts can earn interest like other bank accounts. If the earned interest amounts to $600 or more the buyer must fill out an IRS Form W-9 before receiving the interest. Form W-9 asks for the buyer’s Taxpayer Identification Number so the escrow company sends the IRS notice of the payment.
If the Transaction Fails How Will a Buyer Get the EMD back?
It depends on different situations. If the seller terminates the sale the earnest money always returns to the buyer. The escrow company will either issue a check or make a direct deposit in the buyer’s bank account.
Likewise, if one or more contingencies in the contract fail the buyer gets a full refund. Let’s explore contingencies.
What Is a Contingency in California?
One of our blog posts explains a contingency. It’s titled, “What are Real Estate Contingencies in California?”.
Basically, a home purchase contract contingency is a clause allowing the buyer to back out if the conditions are not met. Three areas of contingencies include an appraisal, financing, and inspections.
Typical contingencies include:
- Appraisal: Every mortgage lender requires a professional appraiser to determine if the sales price is fair market value. If the sales price is under, the contingency allows the buyer to walk away;
- Disclosures: By law, California requires specific disclosures called a “Transfer Disclosure Statement” (TDS) that covers potential problems like structural damage, natural hazards (flood and fire risks), and neighborhood noises;
- Mortgage: Unless the buyer pays all cash, the buyer applies for a home loan (mortgage). If the buyer fails to qualify, the sale gets canceled;
- Inspections: Professional inspectors look for material defects in the home and termites. If discovered, the buyer may cancel the purchase; and
- Clear Title: Sellers guarantee a “clear title” to the property. The seller is the true owner with the right to sell. A “defective title” means the seller’s title is impaired by a court judgment, lien, or another claim to the title. This gives the buyer the right to cancel the purchase.
How To Protect Your Earnest Money Deposit?
Here are some tips to protect your earnest money deposit:
- Include Inspections and Financing contingencies in the contract. These two specifically protect the buyer;
- Read, understand, and follow the contract terms. For instance, follow all deadlines including when you get mortgage approval and completion date for all inspections. Missing one deadline gives the seller the right to cancel the purchase; and
- Handle the deposit correctly. Don’t make a direct payment or write a check to the seller. Make sure your EMD goes to an escrow or title company, or a lawyer. Verify the funds are held in an escrow account and get a receipt.
What is the EMD (Earnest Money Deposit Check) – Conclusion
Now that you learned what is the EMD (Earnest Money Deposit check) follow our suggestions. Like how to protect your earnest money:
- Treat your earnest money deposit carefully by not giving it to the seller;
- Deposit your earnest money with an attorney, or an escrow (or title) company;
- Make sure it goes into an escrow account; and
- Get a receipt.
Buyers: Make sure your purchase contract includes important contingencies like:
- An appraisal at fair market value or more;
- Inspections of the home structure and termites;
- Mortgage approval;
- A clear title of the seller with a title search; and
- Sufficient time to perform all contingencies.
Want to Buy a Home in San Diego County?
Now that you learned how to protect your earnest money deposit let SoCal Lifestyle Realty help you find the ideal home in the greater San Diego area.
Contact us to learn more about earnest money deposits, contingencies, and where your ideal home waits for you in San Diego.
Steven Rich, MBA – Guest Blogger