After an accepted offer to buy a home – the first thing you will have to do is to wire an earnest money deposit to escrow. This amount will stay in escrow until the transaction concludes. The earnest money deposit is not an extra amount you pay to enter escrow, it applies to the purchase price at closing.
But what happens when you have a sudden change of heart during escrow? How do you get the deposit back? Under what conditions the seller can keep your deposit? The California Residential Purchase Agreement and Joint Escrow Instructions is the standard form most agents use for regulating the terms of the deal. This contract is often misunderstood by almost all buyers, sellers, agents, and even attorneys.
Money given to the seller by the buyer and held in escrow as a deposit to be held until the deal closes.
Earnest money deposit is usually 3% of the purchase price. Parties are free to agree on another amount.
No. However, most transactions will require it.
Yes, in most situations. Seller can demand the deposit as liquidated damages if the buyer breaches the agreement.
A pre-determined amount of damages that the parties agree is a reasonable amount in case of a contract breach. The liquidated damages provision in the PSA determines when you can lose the EMD.
Both buyer and seller have to mutually agree to instruct escrow to refund the earnest money deposit to the buyer.
If the seller refuses to refund the earnest money deposit – get in touch with a lawyer immediately. You will have to initiate the right dispute resolution method described in your contract.
What is the Earnest Money Deposit and Why Sellers Demand it Right Away
Earnest money deposit is a good faith amount given to the Seller by the Buyer. It is usually wired to escrow right after both parties enter into contract for a sale of a home. It is also used in commercial real estate deals. The earnest money deposit shows the buyer is serious about the transaction, and increases the likelihood the transaction will close.
The purpose of the deposit is twofold:
- It serves as the amount of liquidated damages if the buyer defaults and does not perform at closing.
- Making sure buyer is ‘invested’ in the deal. By putting money in escrow, buyers are less likely to change their mind. The deposit ensures the buyer is not wasting anyone’s time and is committed to the deal.
What is the difference between the earnest money deposit and the initial money deposit?
Nothing. They both mean the same thing, just a difference name. Here are some of the possible names for the earnest money deposit used by agents:
- Earnest Money
- Initial money deposit
- Security deposit
- “The EMD”
Who gets to determine the amount of the earnest money deposit?
It’s up to the two parties (buyer and seller) to decide the amount of the earnest money. In most cases, the amount will equal 3% of the purchase price. So if you are buying a $2,000,000 home, the seller will ask the buyer to deposit $60,000 as earnest money deposit in escrow. Since all realtors use CAR forms for residential transactions, they are very standardized.
The earnest money deposit can be any amount agreed to by the parties. However, this does not mean the seller gets to keep the entire deposit in cases of a buyer’s breach. This subtle, yet important point is a very misunderstood part of real estate law. The amount has to be reasonable at the time of signing the contract. 3% is considered reasonable by default for single family transactions. For commercial transactions there’s more flexibility.
Can buyers legally refuse to provide an earnest money deposit?
Yes. There is no legal requirement for an EMD to buy a property. However, if your agent uses standard CAR forms – a deposit is required. If the property is listed on the MLS by an agent – prepare to provide a deposit.
Is the EMD refundable?
Yes, as long as the buyer does not defaults during escrow. The most common case buyers lose their deposit during escrow is getting cold feet at the last minute.
Getting cold feet after removing all contingencies is the most common example. If the seller performs their contractual obligations and the buyer backs out, be ready to lose the deposit.
What is Liquidated Damages Clause and how is it related to the Deposit?
Liquidated damages clauses are a pre-determined cap on damages in case of a legal dispute. It is standard in almost all real estate contracts. They are used to limit the potential exposure of damages in case of a lawsuit between buyer and seller. Liquidated damages are also common in business contracts.
The earnest money deposit serves as the liquidated damages amount in real estate contracts. If the buyer defaults, seller can keep the deposit regardless of the actual amount of damages. That also means that if the damages are higher than the liquidated damages – you’re out of luck!
There are limitations on liquidated damages in California contracts. The amount has to be reasonable at the time of signing the contract. For home sales, liquidated damages set at 3% of the purchase price are considered reasonable.
What is the process of getting a getting the earnest money refunded from escrow?
The purchase and sale agreement details the process to get the EMD back from escrow. The buyer’s agent needs to submit a cancellation of escrow form signed by the buyer. After both parties mutually cancel the agreement, escrow is instructed to refund the earnest money deposit to the buyers.
If the seller refuses to release the money from escrow, the parties should lawyer up as soon as possible. In most cases, the parties will attend the required mediation by CAR and try to settle the dispute.
What happens when the seller refuses to refund the initial money deposit?
If you are heading into a legal dispute with the seller, first thing to do is to contact a real estate lawyer. The purchase and sale contract specifies how the parties should mediate disputes related to the contract. In a standard CAR contract, the parties have to start with mediation.
Here are the steps you can take to make sure your deposit is refunded as fast as possible:
- Make sure your agent submits a notice of cancellation to escrow and to the seller as soon as you make a decision not to purchase.
- Don’t remove the loan contingency before full approval from the lender.
- Don’t remove inspection contingency before fully inspecting the property and reviewing the contractor’s reports.
- Make a clear list of timelines of buyer’s responsibilities and abide by them.
- Understand every single Buyer’s obligation under the purchase and sale agreement. You may need an attorney for this one.
Hiring a real estate attorney to get your earnest money deposit back
Escrow won’t refund the buyer if the seller does not sign off on the release. This is where your agent will tell you to seek legal counsel and escalate matters with the seller. If you signed a standard CAR form, you will be required to attend mediation before filing a lawsuit.
Agents and brokers cannot initiate arbitration or mediation. Agents have an incentive to close the deal, their commission depends on it after all. With a lawyer on your side, you can enforce all the terms of the contract that are beneficial to you quickly and efficiently.
It is important to act quickly and not let escrow remain in limbo. If your agent cannot work out a compromise with the seller’s agent, legal action is the only way to force the seller to refund your deposit. The purchase and sale agreement usually determines how the parties resolve legal disputes. The standard CAR for asks the parties to go to mediation first, and if the disputes persists – the parties go to arbitration.
Neither party is allowed to hold the earnest money deposit in bad faith. California Civil Code section 1057.3 states that any party that refuses to sign off a release of funds held in escrow can be liable for up to $1,000 and attorney’s fees.