I recently received this question by email:
Is a E M D asked for when the other party doesn ‘t believe the buyer is serious? Also if I refuse to put down a earnest money deposit do I risk ending negotiations for the property?
A buyer should always ask his or her own agent questions like this. If you don’t trust your agent to give you the right answer you probably have the wrong agent. When you question your agent’s judgement you can always ask for an explanation from the agent’s broker. That said, what follows is not a specific answer to your specific situation, but some general advice about EMD’s.
EMD stands for earnest money deposit. Earnest money deposit literally means money that you’ve deposited to show you are earnest. Nearly every real estate offer these days will include some amount of earnest money to show that the buyer is serious. Offers without any earnest money generally mean that the buyer lacks the capacity to actually make the purchase or that the buyer doesn’t want to risk any money in the transaction.
Nobody likes risk. So what is the risk of putting up an earnest money deposit. An EMD check is in practice often not cashed if the offer is not accepted. An EMD check is usually only cashed when the buyer and seller agree to terms and price. Once that check is cashed it is deposited into an escrow account. That means that the money is NOT in the broker’s bank account. That money is in a separate account that does not comingle with the brokerage’s funds. Once the money is in that account the money generally only comes out one of four ways:
- When the transaction closes. When the sale happens the money is applied to the buyer’s expenses and/or down payment.
- When a judge gives the money to someone. If the sale doesn’t happen and parties cannot agree who to give the money to, a judge will decide who deserves the money.
- When both parties agree to distribute the money. Both parties must agree who to give how much money to.
- When a sale is canceled. There are many reasons a sale might not happen. Sometimes the buyer can’t get financing. Sometimes the home won’t appraise. Sometimes buyers and sellers mutually agree to cancel the sale. When that happens the money is returned to the buyer.
So where is the risk? If the buyer acts fraudulently or negligently the EMD is put at risk. That means that if the buyer lies or attempts to defraud the seller then the sale won’t happen and the money might be forfeit to the seller or the brokerages involved. This doesn’t mean the seller can just take your money if he thinks you’ve lied. The seller can’t take that money. But a judge can take the money and give it to the seller. And the buyer and seller can negotiate to give some or all of the money to the seller.
The Purpose of Earnest Money
When a seller accepts a buyer’s offer, the seller takes some risk. The seller takes some risk because when the property is under contract, he cannot sell the property to other buyers who might be interested. In other words, if the seller agrees to a price with some joker who is just playing around and who won’t buy the house, the seller might miss out on someone who really wants to buy the house. So sellers want to know that if they are risking something then the buyer is risking something.
How much the buyer is willing to risk is usually a good indication of how solid the deal is. We usually advise our buyers to put down 1% of the purchase price as escrow money, but some buyers put down more . . . sometimes much more. The bare minimum you’ll see in most contracts in Northern Virginia is $500 to $1000. Offers with those minimal amounts are rarely accepted, or get a counter offer asking for more earnest money. Very rarely the lower EMD is accepted when the buyer is a veteran using a VA loan, because a VA loan might be more then 100% of the purchase price.
A buyer who puts up a larger EMD is saying to the seller, “I am rock solid. If you accept this deal, you will sell your house.” It sort of like when you buy a car and you pull out the cash and show it to the seller. Then the seller knows you are serious. A buyer who puts up a smaller EMD is saying to the seller, “I don’t have that much money on hand. I don’t want to risk much money because I might not be able to hold up my end of the bargain.”