Once home buyers find a home they love, they declare their commitment to the seller with a sizable chunk of change known as an earnest-money deposit. Yes, it sounds so sincere and serious because it is—and if you get it wrong, you could lose thousands of dollars. To scare you straight, here are eight mistakes with earnest-money deposits that home buyers often make. To ensure you don’t end up as one of them, read on to avoid these snafus.
Mistake No. 1: Not understanding what an earnest-money deposit is
First, make sure you fully grasp what an earnest-money deposit (EMD) is—namely, proof that a buyer is committed to completing a sale by having skin in the game. The earnest-money deposit is a negotiable amount between the buyer and seller, but usually about 1% to 2% of the purchase price (although it can shoot up to 10%). This money is generally held by the seller’s broker or a title company, to be used as a credit toward the down payment and closing costs.
Mistake No. 2: Offering too little … or not enough
In an aggressive seller’s market, many homes receive multiple offers from anxious buyers. For a buyer’s offer to stand out, Washington DC metro area Realtor® Robyn Porter tells her clients to include an Earnest Money Deposit in their offer that will get a seller’s attention. On a $500,000 home, Porter suggests $20,000 to $25,000, or 4% to 5%, depending on the number of competing offers.
However, “I do caution buyers that the Earnest Money Deposit is in jeopardy should they default on the contract, so they should be very serious about wanting the home,” says Porter. Bottom line for buyers: Weigh losing the earnest money against the possibility of losing the home.
If a high earnest-money deposit scares you, remember you’ll have to come up with the down payment 30 to 45 days after making an offer, anyway. “The Earnest Money Deposit is just a way for a buyer to pay part of the down payment upfront,” says Porter. “On a $500,000 mortgage, a 15% down payment is $75,000, so a $25,000 Earnest Money Deposit shouldn’t be a hard pill to swallow.”
Mistake No. 3: Removing contract contingencies
A big mistake buyers make with their earnest-money deposit is agreeing to remove contingencies that give them wiggle room they may legitimately need, says Jeremy Colonna of Matchpoint Funding. For instance, if buyers agree to remove a loan contingency and their loan falls through, they’ll lose their earnest money.
“Never give up your right to cancel your purchase until you are 100% certain that you’re going to be able to close,” says Colonna.
Other contingencies—such as a home that’s un-insurable, inspection issues, a problematic title search, or if a house doesn’t appraise—also protect a buyer by allowing the penalty-free canceling of a contract.
“There may be other instances where the buyer can legally get their EMD back, but these contingencies are the most common,” says Joe M. Lopez, a Realtor in Texas.
Mistake No. 4: Ignoring contract timelines
In some cases, a seller writes in a timeliness clause that includes a hard date for closing.
“Ensuring that you as a buyer stay on the schedule dictated by a contract can assist with not losing your earnest-money deposit,” says Raena Casteel of Arizona’s Casteel Realty Group. This means carefully tracking how long you have to terminate the contract for valid reasons.
Mistake No. 5: Buying ‘as is’ and not knowing the risks
A buyer who purchases foreclosed properties should be cautious with an earnest money deposit, says Realtor Marsha Bowen Washington with Coldwell Banker in northern New Jersey. These properties are typically sold “as is,” so the sellers will stipulate that the earnest money deposit is nonrefundable. As a buyer, protect yourself by doing your due diligence before making an offer on such a property, because if you don’t, you’ll have to kiss your Earnest Money Deposit goodbye if you decide to bail.
Mistake No. 6: Blindly voiding the contract
When a sale falls through, both a buyer and seller need to sign a document voiding the sales contract. If a seller won’t release all the earnest money that a buyer feels legally entitled to, that buyer can refuse to sign the document and essentially make the home unsalable by putting a blemish on the title. In other words: Buyers should never, ever sign this contract unless they’re sure they’ll get all the Earnest Money Deposit they deserve.
Mistake No. 7: Impulsively purchasing a home that’s not a good fit
This may seem like a no-brainer, but it’s easy to get swept away by a home’s cool features when you first see it. A buyer may put in an offer only to realize days later that the soaking tub may be fabulous, but the kitchen isn’t functional. So make sure that you’re 100% serious about buying a home before making an offer with an Earnest Money Deposit.
“If you get cold feet and back out, it’s more likely that you won’t get your money back,” says Casteel.
Mistake No. 8: Not knowing when to let it go
“I had a buyer decide he no longer wanted a home about a week before closing,” says Porter. “He broke up with his fiancee and didn’t want to buy a property where they were going to start a life together. He was willing to lose his $10,000 Earnest Money Deposit, and he did.”
Personal problems may be very serious to you, but they’re not a valid reason to cancel a home purchase. And if you’re bailing on a deal with no legal justification, fighting for that Earnest Money Deposit is probably a waste of time. Just accept that it’s gone and move on.