Remodeling the Way we Buy Homes
Understanding the Earnest Money Deposit
October, 2010 - Issue #72
In California, contracts must contain consideration to be valid. It's a good faith deposit not to be confused with a down payment. When buyers execute a purchase contract, the contract specifies how much money the buyer is initially putting up to secure the contract, to show "good faith," and how much money all together will be deposited as a down payment. The balance is generally financed as a mortgage. An earnest money deposit says to the seller: "Yes, I am serious about buying your house and I'm willing to put my money where my mouth is."

Because there is no set amount, it can vary from market to market. In California, deposits are generally 1 to 3 percent of the sales price. Buyers rarely put down more than 3 percent, since most sign a liquidated damages clause that limits the seller to 3 percent of the purchase price as damages in the event of a default. But it's not unusual for a buyer purchasing a $300,000 home to put down $1,000, especially if the buyer is obtaining 100 percent financing. In those scenarios, the deposit is most often refunded to the buyer and subsequently used as a credit toward closing costs because the financing makes up the entire purchase price.

If it's a seller's market, with many buyers fighting over limited inventory, it makes logical sense for the buyer to put down a much larger earnest money deposit to entice the seller to accept the offer. In a buyer's market, a larger earnest money deposit might entice a seller to accept a much lower purchase price.

In California, the standard C.A.R. purchase contracts allow for the return of the earnest money deposit to the buyer within a specified time period, by default 17 days, if the buyer should elect to cancel the transaction. If, at that point, the seller refused to return the deposit without cause, the seller could end up paying a $1,000 civil penalty to the buyer.

Upon cancellation, the sellers and buyers are asked to sign mutual release instructions. If an agreement cannot be reached, the party holding the earnest money deposit - escrow - will continue to hold it until an agreement is reached. If no agreement has been reached after a few years, escrow companies then send the parties a certified letter asking for mutual instructions. The letter says if nobody responds within a certain time period, then escrow will return the money to the buyer. If the seller contests the action then, after three years, escrow will send the money to the state of California, presumably to help balance our budget deficit.
Jennifer Thompson is owner of and Realtor® with Regal Realty of California; 295-8715
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