What is Earnest Money (EMD) In Real Estate?

Viewers of Saturday morning Popeye cartoons watched with a mix of amusement and disgust as Wimpy the Moocher tried to get others to pay his bill. “I’ll gladly pay you Tuesday for a hamburger today,” he offered the diner chef with a sly smile. Wimpy was rejected, but he found other ways to dodge the check. Homeowners will have no such luck. Not only are IOUs not an option, but many sellers (especially in hot real estate markets) require a good faith deposit, called an earnest money deposit, or EMD. 

What is an EMD? It is money paid to the seller by the buyer to hold their spot until the final paperwork is signed.

The home buying process takes time. Between March 2018 and July 2019, it took an average of 42 days for a home sale to close. Sellers thus want to see that buyers are serious. The EMD is a monetary show of good faith. It is different than a down payment, which is paid upon closing, though EMD is later applied as a credit to the down payment. If you haven’t heard of EMD, you’re not alone. It is a misunderstood, but critical, part of the home buying process in many markets.

The EMD: The Early Decision Application for Home Buyers

In hot markets, sellers are expected to arrive at open houses with mortgage pre-approval letters, as multiple offers will likely be made within the following day. The EMD is a key way sellers vet potential buyers during the home buying process. Here’s why:

 

  •  Without an EMD, buyers could make multiple offers on different home, thus taking them off the market and leaving the seller high and dry. 
  • The EMD compensate sellers if a buyer gets cold feet and pulls out for a reason not outlined in the purchase and sales contract.
  • The EMD is like applying to college via early decision: You are promising that if your offer is accepted, you will choose that home.

Pricing Out the EMD

EMD amount amounts vary by local custom and how competitive (high EMD) or slow (low EMD) the real estate market is in a given area.  It is usually about 1 percent to 2 percent of the purchase price, or up to $4,000 for a $200,000 home. Below are three common scenarios:

  1. Slow markets: The EMD could be 1% or less, in some cases as little as $500 to $1,000.
  2. High-end homes in very competitive markets: The EMD could be as much as 5 percent.
  3. Very competitive situations: Realtors may recommend an even higher EMD to increase the buyer’s chance of being chosen, and sometimes sellers will reduce the sales price in return for the larger good faith payment. 

Remember, offering too low an EMD could falsely signal that you are not serious about buying the home. It is best to take the advice of your real estate agent, who understands all the local ins and outs of the market.

Protecting Your Money

Typically the EMD is requested within one to three days of a seller accepting an offer and is spelled out in the purchase contract. The money rarely goes to the buyer; the EMD is instead paid by cashier’s check or wire transfer  to the escrow account or title company and held until the sale is finalized

Buyers should resist paying the EMD to a seller if requested as it could be difficult to get their money back if something goes wrong. Once the sale is finalized, the EMD is used to reduce the buyers down payment and/or closing costs.

What happens if the sale falls through?

When a buyer pays an EMD, the price of the home and the EMD, along with the terms of the sale, are laid out in the home purchase and sales agreement.

That document includes contingencies, or provisions that must be met for a sale to go through. The five most common contingencies are

  • home inspection to ensure the property is as reported
  • appraisal to ensure the selling price is fair
  • financing in case the lender refuses to finance the loan
  • sale of a current house if the buyer is selling a home, 
  • and title to make sure the title is free and clear to be sold. 

Buyers who wave some contingencies are more appealing to sellers, but they could lose the EMD if the deal does not go through and contingencies are not in place to protect their money. 

Laws governing when buyers get EMD money back vary state. 

When they don’t: Buyers who simply get cold feet don’t get their EMD money back—that is why it is there

When they do: Sellers who take an offer from a different buyer must give the EMD back to the buyer they don’t choose. 

When they might: When closing goes beyond the date listed in the purchase and sales agreement, the seller many try to keep the EMD and make a new closing date. But sometimes, the contract include a closing date, that if not met by the buyer, leads to loss of the EMD. 

What to know: When the sale falls through for disputed reasons, the buyer may need to take legal action to recover the EMD.

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