What’s an earnest money deposit?

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Lucy read my piece yesterday and wanted to know what an earnest money deposit is. I swore up and down I had already written about it. She disagreed. Turns out she was right.

Anyway, an earnest money deposit (EMD) is the money the purchase contract requires the buyer to put into escrow immediately after the contract is agreed between buyer and seller. There is no hard rule about how much money it is, but the convention in southern CA is generally 3% of the total purchase price. If you’re looking at the standard CA Association of Realtors purchase contract, the EMD is set out in paragraph 3A, titled the “Initial Deposit”.

Once the earnest money is in, as with all money in escrow, both buyer and seller must agree before it can leave escrow, either to the seller or back to the buyer. So, once buyer wires the EMD in, he can’t get it back out without the seller’s consent (without going through a lot of hoops, possibly including going to arbitration.)

The point of the earnest money deposit is to:

  1. Show that the buyer is serious (“in earnest”) about buying the property;
  2. Give the seller something (even symbolically) for allowing the buyer to tie up his property for some period of time; and
  3. Give the seller some leverage the ensure the buyer behaves himself.

During the contingency period, while the buyer is investigating the property, the buyer has the right to cancel the deal and receive back his EMD (less some escrow fees, if the escrow company is greedy / stupid). (For more on how the contingency period works, read this.)

Once the buyer removes his contingencies (also called “going hard”), if the buyer does not close the deal, the seller is usually entitled to keep some or all of the EMD (up to 3% of the purchase price, if it’s a 1-4 unit property; otherwise, the whole EMD) as liquidated damages. However, as with all money coming out of escrow, there is a whole process that has to happen before the seller can actually keep the money.

If the buyer does move forward with closing the deal, the EMD ends up as part of the buyer’s downpayment. For example, if the EMD was 3% of the purchase price and the buyer has agreed to put down 25% total, the buyer only needs to wire in a further 22% to close, since the 3% is already there.

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