What is an Earnest Money Deposit and what happens to it? This is the second installment of our Integrity Team Buyer Insider Intel series. (Click here to watch the first video in this series)
Someone asked me today: What is an Earnest Money Deposit, and do you have to have one?
The Earnest Money Deposit, also called the EMD, is a buyer’s guarantee to a seller that they are serious about buying their home.
In simple terms: The amount of the earnest money deposit is what a buyer forfeits if they breach the contract and fail to close on the house, so the amount of the deposit matters.
In the state of Michigan, an earnest money deposit isn’t legally required, but it’s definitely expected.
Now, the amount of the Earnest Money Deposit is negotiable between the buyer and seller. In the past, a deposit of 3% was pretty customary as the minimum. Today, I sometimes see 1-2%, but for higher-priced homes, 3% and up is often expected.
There’s a saying in real estate, “The weaker the deposit, the weaker the deal.” As a buyer, you want a strong deposit in order to be competitive with other offers and to give the seller assurances that they can take their home off the market and trust you to close.
So, what happens to the deposit?
The handling of the earnest money deposit is governed by state statutes. Here in Michigan, the buyer typically will either write a check or wire the amount of the deposit to their broker’s escrow account. Those funds are immediately deducted from the buyer’s account and held in the broker’s escrow account per Michigan statute.
Contrary to popular belief, the deposit is not usually held by the seller or the buyer’s agent.
However, in some cases, like new construction or bank foreclosures, someone else will hold the deposit like the builder, a bank, or a title company.
Once all the contingencies in the purchase contract have been met and the buyer is ready to close, the Earnest Money Deposit appears on the closing documents as a credit to the buyer toward the total funds the buyer needs to bring to closing.
If you are a buyer the question you should be asking then is when your EMD is at risk of being forfeited. That is dependent wholly on the terms of your purchase agreement, but typically, there are a few instances where it is at risk.
First, If there’s an inspection contingency and you are dissatisfied with the results of the inspection, as long as you perform within the terms and deadlines stipulated in the purchase agreement, your earnest money deposit is fairly safe.
However, if you are a day outside of that deadline, the earnest money deposit could be at risk. Make sure you pay close attention to the terms and deadlines in your purchase agreement.
For example: Not supplying the lender with the required information to process your mortgage loan in a timely manner could cost you the deposit. You have to act in good faith.
Misrepresenting your financial situation, whether intentional or by omission, and failing to close could also cost you the deposit.
If you change your mind and decide not to proceed with the sale after contingencies have been satisfied, this is a breach of the contract. You are in default, and typically, your deposit is forfeited.
There are many other situations that could also cause the EMD to be at risk; you should consult your attorney for your specific situation.
It’s important to note that backing out of a purchase agreement could have other consequences besides just losing the deposit. In addition, the defaulting party, buyer or seller, can be sued for “specific performance,” among other things. That nonsense can get super messy.
It’s better to be sure you’re buying the right home before entering into a contract to purchase, then keep your word when you do. That’s what a contract to purchase is, a legally enforceable promise to buy.
The takeaway about the Earnest Money Deposit is that the amount of the deposit is a critical part of your offer. To the seller, It’s not just a deposit; the amount of the deposit is a measure of your level of commitment to closing.
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