There are a number of factors involved in preparing an offer to purchase a home, but one element a first time home buyer may not be expecting is the earnest money deposit. Not to be confused with an actual down payment, the earnest money deposit (or EMD) serves a very different purpose.
I often say the EMD does two things: first, it helps a seller feel more comfortable knowing the buyer has the means to buy their home. And second, by putting some ‘skin in the game’ it assures the seller that the buyer won’t back out at the last minute.
Think of it from a seller’s perspective… a total stranger, who do you don’t know and will probably never meet, makes an offer to buyer your most valuable possession. If that buyer does NOT put any money down with their offer, how confident would you be about them as a purchaser? Your first thought would be “does this person even have the means to buy my house?” And your second thought would be “if I take my house off the market for 30 days and give this person time to do inspections, appraisals and get a loan, what’s to stop them from backing out at the last minute?”
Thus the value and importance of the earnest money. While it is NOT required, it is strongly encouraged, for the reasons above. The next question most buyers ask me is “ok then, how much should it be?” It is important to note that an EMD is NOT the same as a down payment, and it does not need to be as hefty as one. For example, if you were purchasing a $200,000 home and making a 10% downpayment – that rounds out to $20,000.
In our market, a buyer in the $200,000 price range will commonly make an earnest money deposit somewhere between $500-$1000. The amount is up to the buyer, although in some instances a seller can request it to be higher. For properties in lower price ranges, the EMD is usually closer to $500 or sometimes less. And for pricier properties, a higher amount is preferable.
Finally, what happens to this earnest money? Once an offer on a home is accepted and becomes a ratified contract, the earnest money check is cashed and the funds are held in escrow – either by the buyer’s real estate firm or the settlement company handling the closing. The amount of the earnest money deposit is then applied to the buyer’s funds needed at closing.
If the buyer is making a downpayment and/or is paying for all or some of their closing costs, they will need to come to the closing with a cashier’s check for the total amount due… less the amount of the EMD.
While there are other, maybe more important factors in an offer (namely the purchase price and closing date!), the EMD is an opportunity for the buyer to convey their ‘earnestness’ to the seller.