The earnest money deposit (EMD) is a critical part of the home buying process, especially in a competitive seller's market. But how the deposit is used and how it can potentially be lost is often misunderstood.

An earnest money deposit, also known as a good faith deposit, is the cash a buyer offers to show a seller they are serious about purchasing a property.

When a buyer and seller enter a contract, the seller takes the home off the market while the transaction moves through the process to closing. If the deal falls through, the seller must relist the home and start over. Without an EMD, a buyer could make offers on several homes, essentially taking them off the market until they decide which one they want.

Typically, buyers can expect to put down anywhere from 1 to 3 percent of the purchase price as earnest money. In highly competitive markets, buyers may offer even larger deposits to stand out.

The EMD is usually held in a trust or escrow account, and if all goes well with the contract, the deposit is used towards the buyer’s down payment and closing costs.

If a deal falls through, a buyer will typically get their deposit back. However, there are scenarios in which an EMD can be forfeited. 

Waiving contingencies
Most purchase agreements contain contingencies to ensure critical steps of a real estate transaction are successful. Adding contingencies means the closing is contingent upon the satisfaction of certain contract terms, including financing approval, appraisal value, and a satisfactory home inspection.

In highly competitive markets, it is becoming more common for buyers to waive contingencies in order to gain advantage over other buyers. While it can make your offer more attractive, Robyn Dinsdale, vice president of Residential Operations for Diversified National Title, says it can put your EMD at risk.  

“An inspection contingency allows you to renegotiate if serious issues are found during the inspection, or even back out of the deal altogether, and still get your deposit back,” she said. “Without that contingency, if you back out of the deal because of an unsatisfactory inspection, you’ll forfeit your deposit.”

Delaying the process
Real estate contracts typically set a time frame in which a buyer needs to secure financing, get an inspection, have the house appraised, and be available for the closing.

However, it is important to always pay attention to timing and carefully review the wording in your contract. There are contracts that include a timeliness clause, which essentially means if you don’t close on time and the fault is yours, you’re in breach of the contract and could forfeit your EMD.

Changing your mind
Buying a home is a big financial decision, so it’s no surprise that some buyers get cold feet. But remember, the EMD serves as protection for sellers when they take their home off the market. If a buyer suddenly decides they no longer want to go through with the deal, the seller gets to keep the EMD as compensation for the time and money they will spend finding another buyer.

Other considerations
While these are the most common reasons for a buyer to lose his/her EMD, there are a few other considerations. For instance, Dinsdale says buyers can lose their deposit if they change financing programs mid-transaction to something that was not offered as acceptable terms by the seller.

“I have also seen deposits lost because the sellers' disclosure statements were not carefully reviewed,” she said. “If a buyer tries to pull out of a transaction over an item that was clearly covered by the seller’s disclosure, the seller could keep the EMD.”

With so much money on the line, it’s important for both buyers and sellers to work with experienced, local real estate professionals — REALTORS®, lenders, inspectors, title companies, etc. — and review all paperwork and contracts carefully. To find a list of reputable area service providers, visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.