The earnest money deposit is an important concept for both home buyers and home sellers to understand. In California, once an offer is accepted by the home seller, a home buyer places an earnest money deposit into an escrow account. This money is counted towards the home buyer’s down payment and is a good faith gesture to the seller.
So, how much is an earnest money deposit? Typically, it’s between 1 to 3% of the purchase price. The higher the deposit, the stronger it makes a home buyer’s offer. In a seller’s market, like the one we are currently experiencing in San Diego, a 2 to 3% earnest money deposit is more appropriate. However, this deposit is completely negotiable between the buyer and seller.
Earnest Money Deposit = Initial Deposit
The earnest money deposit is referred to as the “initial deposit” in paragraph 3 of the California Residential Purchase Agreement. The image below shows where this is in the contract.
One of the most confusing aspects of a real estate transaction in California is understanding who gets the earnest money deposit if an escrow is canceled. At my weekly team meeting at the Keller Williams San Diego Metro office, we discussed this important issue. In this post, I share what we learned. Here are 5 different situations that may come up during the escrow process and I will tell you who is entitled to receive the earnest money deposit based on the situation.
In each situation, let’s assume that the contract states a 17 day contingency period.
Q: If a buyer who has not removed contingencies wants to cancel a transaction on the 17th day for no reason whatsoever, can a seller retain a buyer’s earnest money deposit?
A: No. In the California purchase agreement, the buyer has a contingency period to review disclosure documents, to conduct an inspection of the property, to consider the findings of the inspection, to secure financing, and receive appraisal approval. If a buyer decides to cancel the transaction at any time, before the contingency period expires, the buyer is entitled to their full earnest money deposit. The buyer needs just about no reason, good or otherwise.
Q: If a buyer who has not removed contingencies wants to cancel a transaction on the 29th day, for no reason, and the seller has not given the buyer a Notice to Perform, can the seller retain the buyer’s deposit?
A: No. If the buyer does not remove all contingencies, in writing, by the expiration of the contingency period, the contingency period simply continues! Unless the seller delivers a written Notice to Perform to the Buyer, the 17-day time limit is essentially meaningless. Thus, if the buyer walks on the 29th day of a 30-day escrow and the seller has not given the buyer a notice to perform, the seller has to return the buyer’s deposit. This can be an extreme hardship in cases where the seller is buying a replacement property and/or has already moved out in anticipation of the closing.
Q: What happens if the 17th day comes and the buyer has not removed contingencies, yet the seller gives the buyer a Notice to Perform and on the 23rd hour, the buyer cancels the agreement? Can the seller keep the buyer’s earnest money deposit?
A: No. If the buyer cancels at any time before the expiration of the Notice to Perform, the buyer gets his or her money back.
Q: What if the 17th day arrives, the buyer hasn’t removed all contingencies, the seller gives the buyer a Notice to Perform and the buyer doesn’t cancel or remove all contingencies by the expiration of the Notice to Perform? Can the seller keep the buyer’s earnest money deposit?
A: No, but the seller has the right to cancel the contract.
Q: If a buyer wants to cancel a transaction, when can a seller retain a buyer’s earnest money deposit without encountering any problems doing so?
A: Just about never. Even when a buyer wants to cancel and the seller has done every piece of paperwork correctly and timely, the buyer can still create a very unpleasant and time-consuming situation for a seller. The buyer can demand their deposit back even when the buyer shouldn’t be getting their deposit back. The buyer can refuse to sign escrow cancellation instructions unless the buyer gets the deposit back, and the seller has to sell it to the next buyer “subject to” the successful cancellation of the previous escrow. Meanwhile, the deposit remains in the first escrow and buyer #1 and the seller have to resolve the issue before the sale to buyer #2 can close escrow.
California Law Favors Buyers
Did you notice a pattern? It’s clear that California real estate law favors the home buyer by giving them many opportunities to cancel an escrow while retaining their initial deposit. If you plan on selling your home, it’s important to understand that the earnest money deposit is highly protected so a savvy listing agent will assist you in qualifying the prospective buyer.
As a prospective home buyer in California, feel secure that your initial deposit is safe, but you should do everything in your power to meet the timelines in the agreement and do your due diligence during the contingency period of the contract. Your agent will guide you through the process and ensure that you are reminded of all critical deadlines in the escrow process.