When buying a home, you will encounter a lot of new terminologies and new concepts that may seem confusing and overwhelming. There are several moving parts when buying a home, but working with a real estate professional will help keep everything on track. While you may have several questions throughout the buying process, one of the common is concerning the earnest money deposit, especially when a contract falls through.
You may take the EMD for granted as just part of the process — until a deal falls through, you are losing earnest money and thousands of dollars are in jeopardy. The unexpected can happen prior to closing so it is vital that you understand what is at stake.
Before you write that check, find out the purpose of an Earnest Money Deposit (EMD) and how to avoid costly mistakes on the home purchase.
What is an Earnest Money Deposit?
Before explaining how you can lose an earnest money deposit, you need to know what it is first. When buying a home, most people are required to put money in escrow to prove that you are serious about moving forward. This money is typically written into the purchase agreement as an Earnest Money Deposit (EMD), or referred to as a good faith deposit so the seller can be assured that they are not wasting their time with you.
EMDs are not legally required, but sellers can contractually require them. By putting thousands of dollars into a third parties escrow account, you have “skin in the game” as you will be at risk of losing money if you do not follow the terms of the agreed-upon contract. The earnest money requirement prevents a real estate buyer from making offers on many homes since the offer essentially takes the property off the market until they decided which one they liked best. Sellers rarely accept offers without the buyers putting down earnest money to show that they are serious and are making the offer in good faith.
Assuming that all goes well and the buyer’s good-faith offer is accepted by the seller, the earnest money funds go toward the down payment and closing costs. In effect, earnest money is just paying more of the down payment and closing costs upfront. In many circumstances, buyers can get most of the earnest money back if they discover something they don’t like about the home.
Ways to Lose Your 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 some common scenarios where you can lose earnest money deposits.
1. Failing to Meet Deadlines
Your contract includes a timeline that you must follow in order to get to the closing table. Sometimes deadlines need to get shifted a little, but both parties must agree to new dates. As you read the contract, pay close attention to the specific time frames outlined. The real estate contract outlines the time period for securing financing, getting a home inspection, negotiating repairs, having an appraisal and the closing date.
If you see a “time is of the essence” clause, it is a must to complete the tasks on-time, or you could be in breach of the contract.
2. Getting Caught Up In a Bidding War
Low-inventory markets with high demand could result in multiple offers and bidding wars on every new home that comes on the MLS. In that kind of heated atmosphere, buyers can feel pressured to make an offer on anything that becomes available. In addition, they may include higher than normal EMD’s to sweeten their offer. If you realize too late that you made an offer that was accepted but you cannot follow through with, you may lose out on that deposit. Make sure you keep a steady head in the midst of a high-pressure market so that you can avoid this type of mistake.
3. Agreeing to a Non-Refundable Earnest Money Deposit
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. Make sure you read the fine print and understand the verbiage before signing that check.
4. Waiving Contingencies Prematurely
In a multi-offer or hot market situation, buyers may be wary about asking for too much from the seller in order to get under contract. They can waive their right to contingencies including requesting repairs or price adjustments after a home inspection. Offers that waive contingencies, such as real estate financing or inspections, can be more attractive to the seller. However, these contingencies are in place for buyers to get their earnest money back if they cannot purchase the house due to a reason covered by the contingencies or the inspection period reveals serious issues.
Waiving these contingencies could mean losing your EMD if you, as the buyer, back out of the contract.
5. Failing to Do Due Diligence
If you are a bargain-hunter or a desperate buyer in a hot market, you 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 you later discover that the home has some costly problems, you may need to sacrifice that EMD in order to get out of the contract.
6. Failing to Understand “As-Is” Buying
If you are handy enough to tackle a fixer-upper, you may be eager to take advantage of the money-saving opportunities offered by an As-Is property. However, major structural damage, termite damage, or other systems failure could result in more than you bargained for. A home inspection contingency with the stipulation that no repairs will be requested could be necessary. Otherwise, you could find yourself losing your earnest money deposit to back out of the contract.
7. Deciding the Home Isn’t “The One”
There is not a clause in the purchase agreement that allows you to back out of the contract because you realize the house is not the right fit or you find a “better” house. If you have a change of heart after seeing the house again or seeing another house that just came on the market, you will most likely have to forfeit your deposit if you back out.
8. Change of Circumstances
Sometimes personal reasons pop up and make it impossible to continue on with a purchase. This could be an illness, a broken engagement, an unforeseen divorce, a job loss or change. While this was not something that you could have planned for, the seller is under no obligation to return your deposit, although you could make a plea depending on your situation.
The last thing any home buyer ever wants to do is put down money to buy a home and lose it, but it happens. There are many ways to lose your earnest money deposit. If you don’t understand how your deposit is handled, you should ask questions at the time you make an offer. Ask to see the verbiage in the contract that guarantees the return of your deposit. Not every purchase contract affords this type of protection.
When choosing an escrow company there can be many important factors to evaluate. Fees, location, staff and even recommendations from friends and colleagues are all things to consider. With Citrus Heritage Escrow by your side, you can rest assured that when you receive your settlement check, you’ve gained the maximum benefit from your home sale or purchase.
Call us today with any questions or concerns. Our professional Escrow Agents will help you through this exciting yet confusing process. (951) 335-7200