Before your buyers write that check, find out the purpose of an Earnest Money Deposit (EMD) and how to avoid costly mistakes on the home purchase.
Before your buyers write that earnest money check, find out the purpose of an Earnest Money Deposit (EMD), how to avoid costly mistakes on the home purchase, and ways to lose earnest money.
They’ve found the home of their dreams and you’re working with your buyers to put together a winning offer. Part of that involves writing a fairly hefty check for the Earnest Money Deposit or EMD. You may take the EMD for granted as just part of the process -- until a deal falls through, you're losing earnest money, and those thousands of dollars are in jeopardy. The unexpected can happen prior to closing so it’s vital to explain to your buyers what’s at stake, ensuring that they are not blindsided by the loss of an Earnest Money Deposit.
How can you lose your earnest money deposit? Whether it involves a change of heart or a change in circumstances, here are ten scenarios where you can lose earnest money deposits-- and ways to protect your clients.
When your buyers sign a purchase contract, they also agree to a timeline for home inspections, contingencies, and closing. If these major milestones along the road to the closing table don’t happen, the transaction could be put into jeopardy -- and that would be the buyer’s fault. If they are unable to fulfill the terms of the contract, the sellers would be justified in working to find another buyer -- and keeping the EMD. Make sure you are keeping your buyers moving forward with effective transaction coordination so that they are able to meet their contractual obligations on time.
We’ve all experienced low-inventory markets with multiple offers and bidding wars on every new home that comes on the MLS. In that kind of heated atmosphere, buyers can get scared and desperate -- causing them to jump the gun and offer on anything that becomes available. In addition, they may include higher than normal EMD’s to sweeten their offer. If they then realize the house is not for them, they could find themselves losing thousands when they back out of the contract. Make sure you help clients stay steady in the midst of a high-pressure market so that they can avoid this type of mistake.
In some purchase scenarios, especially those involving bank-owned properties or investment properties, a non-refundable EMD may be required in order to show that the buyers are serious about seeing the transaction through. If your clients are confident that their financing and other contract requirements are on track, this may be worth it to them. However, make sure that they have a clear understanding of this part of the contract before they sign that earnest money check and sign away their rights to a earnest money deposit refund.
When you are putting together an offer in a multiple offer situation, you may be nervous about asking for too much from the sellers. In that case, you may add fewer contingencies to the sales contract. Alternatively, once you’re under contract, you may mistakenly assume that some of its requirements have been fulfilled and release those contingencies prematurely. In either case, a lack of adequate contingency protection can lead to a cancelled contract or a cancelled earnest money check-- and a lost EMD.
If your client is an investor or just a bargain-hunter, he or she may find a great deal and be eager to act on it, going under contract without a home inspection or other due diligence. In fact, part of the value-add many investors offer is an inspection-free process and fast closing. If the client then finds out that the home has some costly problems, he or she may need to sacrifice that EMD in order to get out of the contract.
Many ask "when does a buys lost earnest money?" Well, some buyers are eager to take advantage of the money-saving opportunities offered by an As-Is property, assuming that they are handy enough to tackle a fixer-upper. However, major structural damage, termite damage, or other systems failure could result in more than they bargained for. In this case, it is important to have a home inspection contingency with the stipulation that no repairs will be requested. Otherwise, your buyers could find themselves losing their earnest money deposit to back out of the contract.
In the case of a mutual decision to void a sales contract, it is important that the full earnest money refund is stipulated clearly in order to ensure that the seller isn’t planning to keep some or all of it. Once the contract is void, the buyer has given up any possible leverage they would have in order to compel the seller to release their deposit.
Do you get earnest money back? Do you lose earnest money if you back out? For many people, buying a home is a very personal and emotional decision. For this reason, some buyers may decide on second or third viewing that the home just isn’t the right one for them. Since there is no contingency for a change of heart, it is important that buyers know that canceling the contract without cause may result in the loss of the EMD.
Just like falling in love, some buyers may enjoy the pursuit more than the capture -- falling in love with one home until they go under contract, then worrying that the right one is still out there somewhere. Here too, this emotion-based reason for canceling a contract will generally be punished with the loss of the EMD -- in part because of the loss in value anticipated by the sellers when they have to put their home back on the market.
Finally, a big reason that contracts fall through -- other than home condition or financing issues -- stems from personal issues on the buyer side. An illness, a broken engagement, an unforeseen divorce, a job loss or change -- any of these can result in a fundamental shift in planning for the buyer and a genuine inability to see the contract through to closing. In these cases, the sellers are justified in keeping the EMD. In cases of hardship, you may make an appeal on the buyer’s behalf, however the sellers are under no obligation to return the deposit.