Buying Real Estate in Santa Rosa;
The Earnest Deposit in a Real Estate Transaction

What is the Earnest Deposit and Liquidated Damages?

The buyer’s earnest deposit is the money that the buyer initially deposits into escrow, and is a reflection of their good faith in the real estate transaction. It is sometimes called a “Good Faith Deposit”. When buying a home in Santa Rosa, Windsor or the surrounding area, the earnest deposit should be in the form of a check written to the Title Company (NOT to the seller, not to the real estate agent, not to the agent’s company). These funds will be held by the title company until the escrow closes, or both Buyer and Seller mutually agree to cancel the escrow and release the funds.

There is a common misperception in Sonoma County that the buyer's deposit can not exceed 3% of the purchase price, but this is not correct. The buyer's deposit can be any dollar amount that the buyer feels comfortable to offer, and the seller is willing to accept. It is whatever you agree to. When submitting an offer to purchase a home, the buyer will specify how much time they need to get financing, make inspections, prepare to move, etc. Generally speaking, the deposit amount should reflect the length of time the buyer has requested. The more time the buyer is asking for, the larger the deposit will typically be. In a typical Santa Rosa real estate market, a deposit equal to 1% of the purchase price for every 30 days of escrow is common. A 60-day escrow might therefore have an earnest deposit equal to 2% of the purchase price of the home. The amount of the deposit is, of course, fully negotiable and will depend on what type of market conditions exist at the time of the offer. In a strong Seller’s market, the deposit may need to be higher. In a strong Buyer’s market, the deposit may be lower.

Liquidated damages do not involve water

Liquidated damages are not the same thing as the earnest deposit. A liquidated damage “clause” is often found in the purchase agreement. This clause typically states that if the buyer defaults on the agreement, the seller is allowed to keep either the buyer’s earnest deposit or 3% of the purchase price, whichever is less. It is this last part that creates the confusion with the Earnest Deposit. The earnest deposit can be any amount, but the Seller’s liquidated damages clause will only allow the Seller to keep an amount that is 3% of the sales price, or less.

Liquidated damages are intended to pay for the seller's reasonable costs which have been created by the buyer’s failure to comply with the purchase agreement. Due to California laws, Liquidated damages in many California residential purchase agreements are normally limited to a maximum of 3% of the purchase price.

The Sellers View on the Earnest Deposit

The buyer’s deposit is useful to the seller of a property in several ways. First, it can be an indication of the strength of the buyer’s offer. Typically the more confidence a buyer has that they are willing and able to complete the real estate transaction; the larger deposit the buyer is willing to offer. This tends to be a more accurate indication in a sellers market than it is in a buyer's market. Secondly, the buyer's deposit is used to fund the liquidated damages portion of the purchase agreement in a situation where the buyer has defaulted on the agreement. Remember that liquidated damages are usually limited to a maximum of 3% of the purchase price of the home, or the amount of the buyer’s deposit, whichever is less.

Therefore from a seller's perspective, the buyer's deposit should be at least 3% of the purchase price of a home. The amount of the buyer's deposit is obviously determined by negotiation between the buyer and seller and will be influenced by the type of market conditions that exist at the time. In a strong buyer's market, many sellers will be happy to get any offer regardless of the amount of the buyer’s earnest deposit. Conversely in a strong seller’s market, perhaps no offers are considered without a 3% deposit. It is important to be sure that the timeframes in the purchase agreement are both legal and aggressive on the seller's behalf. A properly structured buyer’s deposit can act as a significant motivator for a buyer who is having second thoughts about their decision to buy and can help minimize the seller's risk for removing the property from the market. Except in unusual circumstances, I would counsel my listing clients to reject an offer without a sufficient deposit. In most cases this is a red flag for an offer that is not really serious.

Remember that just because the buyer doesn't close escrow on the property, doesn't necessarily mean that the seller is entitled to liquidated damages. The buyer must default on the agreement before the seller may consider keeping the liquidated damages. There are plenty of opportunities in the purchase agreement allowing the buyer to cancel the escrow and still be in conformance with the agreement. For this reason, it is critically important that the listing agent continuously counsel their client about the buyer’s contingencies and the associated deadlines as stated in the agreement. Nobody needs a wild cannon going off on deck just because the parrot called fowl. Now you know why I am not in comedy.

The Buyer's View on the Earnest Deposit

In most normal markets, the buyer's deposit is a required part of any offer to purchase real estate. It is required by sellers to help protect them from a buyer who could change their mind at the last minute, without good cause. There are expenses the seller will incur during the escrow period as they continue to pay the mortgage, maintain the property, pay utilities and taxes, make buyer-requested repairs, etc. The last thing a seller wants to happen; is to go through a long escrow, with all the associated expenses, only to have the buyer decide at the last minute that they “prefer” to purchase a different property.

For these reasons, it is inevitable that the Buyer will need to determine some dollar amount they are willing to offer as a deposit towards the purchase of a particular property. Remember that the earnest deposit is applied towards the costs of buying the home; it is not an additional cost on top of the purchase price.

The Earnest Deposit is a BIG Deal to the Buyer

From a buyer's perspective, the earnest deposit is a "very big deal". It is a large sum of money that is placed in escrow upon acceptance of the offer, and is completely “at risk” if the Buyer defaults on the purchase agreement. A good buyer's agent will help them write a purchase agreement that includes contingencies designed to protect the Buyer during their discovery and financing period. The Buyer may discover some problem with the property during their “inspection phase”, or fail to secure financing during the time allowed by the agreement. It these cases, the Buyer must have contingencies written into the agreement that allow them to cancel escrow and have their deposit fully refunded.

Remember; after all the inspections and other requirements are completed and the Buyer is satisfied, they will release their contingencies written in the agreement and must then be ready and able to close escrow on the property or risk losing some or all of the deposit. For this reason it is critically important that Buyer’s understand all contingencies in the agreement and the associated deadlines, and that they carefully monitor their progress. A good buyer's agent is a tremendous asset during this stage of the real estate transaction because they will help the Buyer through this process and can provide solutions to problems that occur along the way.

BIG is not the same as BAD

The buyers deposit is a “big deal”, but is not a “bad thing”; it just needs to be fully understood and properly managed. A creative buyer's-agent can help turn this "requirement" into a positive asset for the buyer. For example a good buyer's agent might coach their client that the buyer’s deposit can be a tool to achieve a lower purchase price. One of the most important things in the seller's mind when considering an offer is; “What are the chances this buyer will close escrow?

A higher deposit amount indicates a strong intent on the part of the buyer to seriously work hard towards the completion of the transaction. Provided that the contingencies in the purchase agreement are properly structured so that the buyer is still fully protected during their discovery and financing period, in many cases a larger deposit can convince the seller to accept the Buyer’s offer in favor of competing offers with lower deposits. Best of all, when you close escrow, this higher deposit doesn’t cost you anything. If you a Buyer is truly serious about their interest in a property, they can reflect this in the amount of their deposit, and gain some pricing benefit from the deposit.

Both Sides Can Find Protection

The two most common reasons a property does not close escrow are because the buyer could not get financing, or the buyer found a problem with the home that wasn’t obvious. BOTH of these are controllable issues and BOTH of these can easily be protected in a properly written purchase agreement. Any buyer considering the purchase of a home should be preapproved by (at least one) committed lender ready to lend to THEM. A seller can have a home inspection completed PRIOR to even going to market and therefore insure few if any surprises.

Click Here to learn more about the author of this article

If you have any questions about this article, or would like additional information, please Contact Me and I will be happy to help you in any way possible.

To get today's breaking news about Sonoma County real estate and recent Market Trends, visit our BLOG