When purchasing a house or any property, a buyer is often required to pay some amount to the seller as a mark of commitment to make a purchase. This initial amount that a buyer pays to the seller is referred to as a good faith deposit or earnest money deposit (EMD). The payment is usually made immediately after both parties have agreed to the terms of the sale, mostly before closing the transaction.
Earnest Money Deposit (EMD): Meaning
An earnest money deposit refers to a sum of money that a property buyer pays to show his intention and commitment towards purchasing a property. This gives the seller a sign that the buyer is genuinely interested in buying a property. It also protects the buyer or seller from breaking away from the deal. However, a buyer may lose the money if they back out of the deal.
It is essential for both the buyer and seller to understand the terms of the EMD as this may vary depending on the local laws in the area or the contract. One can also take the help of a legal professional or real estate expert.
See also: What is down payment on home loans?
How does Earnest Money Deposit work?
Submission of offer: Once a buyer decides to make an offer on a deal, they include an EMD with their offer. The amount is typically a small percentage of the total purchase price for the property.
Escrow account: After the offer is accepted, the EMD is placed in an escrow account. An escrow account refers to a third-party account where funds are placed in trust while the two parties complete the transaction.
Protection for sellers: The earnest money deposit is a protection for the seller in case the buyer backs out of the deal without any reason. In such a case, the seller is allowed to keep the amount as compensation for the time the property was off the market.
Credited to purchase: In case the sale takes place, the earnest money deposit is credited towards the buyer’s down payment or closing costs.
Is Earnest Money Deposit refundable?
If a property buyer acts in good faith, the earnest money deposit is refundable. There may be specific conditions or contingencies included in the contract under which a buyer is allowed to get the EMD refunded.
For example, in case one discovers during a home inspection that there are significant issues with a property, the buyer can back out of the purchase or negotiate who is responsible for the repair.
Why should a buyer pay earnest money?
Mostly, sellers request for the earnest money deposit as it protects the interests of both the parties. Moreover, the amount goes into the escrow account, ensuring transparency.
If the seller removes the property from the market while waiting for outcome of the appraisal and home inspection, the amount protects his interests while proving that the buyer is serious about buying the property. It also serves as an advance the buyer pays for the property purchase and it is considered in the buyer’s closing costs or down payment. For example, a buyer may pay Rs 5 Lakh for a property having a value of Rs 50 Lakh.
Benefits of Earnest Money Deposit
Increases credibility of the offer: Earnest money deposits are common in a competitive market, especially if a seller is concerned that a buyer may make multiple offers on several properties. It shows that the buyer is financially equipped and serious about the property purchase.
Proves good faith of the buyer: Paying the EMD shows the buyer is sincere and willing to purchase the property, giving an assurance to the seller.
Allows a buffer period: When a buyer pays the earnest money deposit, he is allowed time to arrange funds for the down payment. During the buffer period, a buyer may also get property inspections, appraisals and due diligence conducted.
Included in down payment: The earnest money deposit is considered a part of the buyer’s down payment. Typically, it reduces the overall amount to be paid by the buyer during the purchase.
Saved in escrow: An escrow account is a neutral third-party account managed by the lender to maintain the funds for property-related expenses, such as insurance, taxes, etc. Thus, the earnest money deposit is secured and cannot be accessed by either buyer or seller until the deal is finalised.
Negotiable: The amount a buyer needs to pay as an earnest money deposit is negotiable. Usually, factors such as local market trends, property value, terms of the contract, etc., are considered when deciding the amount. The seller may also mention the minimum EMD when listing the property.
How to protect your earnest money deposit?
- The buyer must request a receipt for the earnest money deposit. It will serve as a proof that they had paid money.
- It is essential to check if it is kept in an escrow account to ensure the earnest money deposit is secure.
- Make sure to go through the agreement terms and the conditions under which one may lose the earnest money deposit.
- Organise a home inspection as it can help identify any problems with the property beforehand and save unexpected expenses in future.
- Consulting a real estate agent is beneficial as they help negotiate the purchase and protect buyer’s interests.
FAQs
What is the purpose of the EMD?
An earnest money deposit is paid by the property buyer to express his commitment towards buying a property.
Is earnest money deposit refundable?
An earnest money deposit may be refundable if the contract lays down specific conditions. Usually, the amount is counted as part of the buyer’s down payment.
Who pays earnest money deposit?
The earnest money deposit is paid by the buyer before purchasing a property.
How is EMD calculated?
An earnest money deposit is calculated by considering a small percentage of the total price for the property purchase.
Why do buyers pay earnest money?
Buyers pay EMD to show that they are financially equipped and serious about the property purchase.
Is earnest money deposit to be paid for a home loan?
Earnest money deposit is not required for obtaining a home loan. It is usually paid by a property buyer to the seller at the time of making an offer to purchase a property.
What is the difference between earnest money and down payment?
A down payment is the amount paid for the total purchase price. An earnest money deposit is considered a part of the down payment.
How much should a homebuyer pay as earnest money?
The buyer’s offer of EMD will depend on the market trends, property value, etc. Typically, a good-faith deposit ranges between 1% and 3% of the property’s purchase price. In competitive markets, the percentage of EMD may be up to 10%.
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