What is the Earnest Money Deposit

Of course, you know that you’ll need to pay a down payment on any home you hope to purchase with a mortgage (unless you’ll be using a VA or USDA home loan). But, did you know that you will also need cash for an “earnest money deposit?” Indeed you will, and it’s a fact that surprises many first-time homebuyers.

While the down payment is a lender requirement, the earnest money deposit is for the seller, and it shows him or her that you are earnest in your desire to purchase the home. Because you now have skin in the game, the seller can relax a little as the home comes off the market.

The amount of an earnest money deposit varies; there is no law dictating how much it should be. Therefore, it varies, according to region. Let’s take a look at how the amount of this deposit is usually determined.

Liquidated Damages

Buried within most pre-printed real estate purchase agreements is a clause known as “Liquidated Damages.” This concept is defined well by Bob Hunt, former director of the National Association of REALTORS® and author of "Real Estate the Ethical Way." Hunt says that “A liquidated damages clause sets in advance - at the time of contract formation - what the monetary value of damages shall be in the event of contract breach by one of the parties.”

In other words, if the buyer fails to complete the transaction according to the agreement, the seller agrees not to sue but to keep whatever amount of money the parties have determined will cover damages.

So, what do liquidated damages have to do with your earnest money deposit? If you default on the purchase of the home, this deposit will be forfeited as liquidated damages. Therefore, an experienced listing agent will insist that the amount of the earnest money deposit is equal to the percentage of the sales price listed as liquidated damages.

How Much?

As mentioned earlier, the amount of earnest money you’ll need to deposit varies by region. There are other caveats that vary as well. For instance, one percent of the purchase price may be standard in many regions but the buyer is typically asked to increase the deposit to equal three percent after the removal of contingencies.

Your real estate agent can structure the offer to purchase to keep this deposit as low as possible.