What Buyers Should Know About the Earnest Money Deposit

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When buying a home, your offer price shouldn’t be the only dollar figure to concern yourself with. There’s also the earnest money deposit that you need to seriously consider.

An earnest money deposit serves to benefit both the buyer and the seller. From the buyer’s perspective, offering a handsome deposit in the form of a money order or certified cheque shows sellers that they’re serious about buying and are financially qualified to make a purchase. This, in turn, puts buyers in a more competitive position and pushes them one step forward towards a successful deal.

For sellers, an earnest money deposit offers protection should the buyer fall through on the deal for whatever reason. If the buyer breaches the contract, the seller may be able to retain the money from the deposit as a means of collecting on damages. Earnest money deposits basically reassure sellers that they have something financial to fall back on if the buyer causes the deal to fizzle out.

With all that being said, there are some things about the earnest money deposit that all buyers should fully understand before cutting that check. After all, it’s a sizeable amount of money to part with.

How Much Should You Offer?

The answer to this question will ultimately come down to the temperature of the current market in your area and what the seller is demanding. Having said that, it’s typical to offer about 3% of the purchase price.

In lukewarm markets where homes aren’t being sold very quickly, you can expect to put down a deposit even a little lower than 3%, while buyers may offer even more in a sizzling market. If you find yourself in the middle of a bidding war, you can use your earnest money deposit as leverage to make the seller notice you. The higher the deposit amount in this situation, the better.

Some sellers may not want to work with percentages. In this case, they may ask for set amounts instead. Don’t forget that your deposit amount goes towards your down payment, which you’ll have to pay anyway.

When Do You Pay the Deposit?

The average real estate deal typically requires the buyer to submit their deposit check shortly after the offer has been accepted. If you’re dealing with a hot market, it’s suggested that you provide your earnest money deposit along with the signed contract.

Who Keeps That Money Until Closing?

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Your deposit check will not be given directly to the seller, for obvious reasons. Instead, your money is kept by the title company or in a professional escrow account. At no time are brokers permitted to deposit any earnest monies into their own business accounts. That said, it’s important to ask for a receipt for the earnest money you supply as a deposit.

You may also be entitled to collect interest on these funds. Anything over the amount of $5,000 may qualify, but you will have to fill out IRS Form W-9 if you want the interest money.

What Happens if the Deal Falls Through?

Not all real estate deals successfully close. Sometimes issues arise that may cause the deal to fall through. As long as there are contingencies included in the contract that provide you with the opportunity to back out of the deal, there should be no reason not to get your earnest money deposit back.

For instance, typical contingencies for financing and home inspections allow buyers to back out of a deal and get their deposit back should they be unable to fulfill them before their respective expiry dates. That’s the whole point of including contingencies in a real estate contract, and you’d be well advised to put them in before you sign off.

But if the closing date comes and goes and you’re still unable to close the deal, the seller may come after you for damages. In this case, they’ll try to retain your earnest money deposit as a means of financial protection.

In many cases, buyers are held liable for their inability to follow through with the deal and their earnest money deposit is not considered the sellers to keep. That said, there is a limit to how much the seller can take from you.

If a Liquidated Damages clause is included in the real estate contract, no more than 3% of the agreed-upon purchase price can be kept by the seller, even if you fail to complete the purchase. That’s why it’s typical for the earnest money deposit to be around the 3% mark in California.

The reason behind liquidated damages is to set forth provisions about how damages are to be dealt with should the deal fall through. It can be tough to predict actual damages that can happen if a contract is breached, so both parties agree to limit any damages to the earnest money deposit if they sign off on this clause.

It’s a good idea to ensure that the purchase agreement covers how the refund of the deposit money is handled and to consult with a real estate lawyer if a breach of contract occurs and your funds are on the line.

The Bottom Line

When you’re talking about thousands of dollars being handed over at the time of contract signing, you’ll certainly want to fully understand how your earnest money deposit is handled. Make sure you’re in-the-know about these funds and the role they play in a real estate deal before determining how much to offer and handing it over.

Since every transaction is unique, coming up with the appropriate strategy necessitates a thorough understanding of market conditions in your area. Before making your decision about how much to offer for your earnest money deposit, be sure you speak with your Realtor.