Time and again, the issue of how much to offer on an earnest money deposit comes up. There even seems to be a lot of confusion among agents as to what is appropriate. I have read a lot of articles that say between 1% to 3% is the going rate in California. In my experience, this certainly seems to be appropriate, however with the preponderance of 100% financing programs, both buyers and agents often try to put as little as possible. In addition, with rising prices, many people do not have 3% readily available. At today’s prices that represents a substantial amount of free cash.
Let’s first examine what an earnest money deposit is, and why it is important. In California, in order for a real estate contract to be valid, consideration must be exchanged. It can be any agreed upon amount. The practical purpose of this deposit is to secure the real estate purchase contract and help protect the seller from loss in the event of a buyer breach in the contract.
When a seller agrees to sell a home, there is risk that goes along with putting a home into escrow. The seller will probably be spending money he or she may or may not have to effect repairs including termite work. In addition, all of the service providers (such as title and escrow) would charge a cancellation fee if the escrow were to go the end and then fall apart. Lastly, the seller is often required to make a commitment to new housing accommodations. If it is a rental, then a security deposit and first and last months rent is required to secure an apartment or temporary housing. In a worst case scenario, the seller may be putting a deposit on a new home, possibly a much larger deposit that could be at risk.
A typical example might be $1,000 for termite and repairs, $800 in cancellation fees, and $3500 to $10,000 towards a rental or other deposit. Lets not forget that if the property is vacant and the seller has the property off the market for 30 days then he might have to eat the cost of the mortgage (maybe $3000) plus and additional month to re market the property and another to re escrow the property ($6000). If the market is going up, the seller would benefit from rising prices to help offset costs, but in a market with downward pressure, the seller might have to resell at a loss to effect a quick sale. Ouch!
Are you getting the picture? The typical escrow that falls apart might cost the seller between $3500 to $20,000 or more. Having a good size earnest money deposit takes the worry away from the seller as he 1. knows you are serious about the property, 2. knows you are not likely to walk away from a large deposit in the final hours, 3. knows that if you do, his losses will be mostly covered and 4. most important to the negotiation, a good size deposit demonstrates that you have financial means (yes, even if you are doing a 100% financing program).
When writing an offer, its common for a moment of fear to come upon the buyer, “what if I loose my money.” This certainly is a valid concern. In California, the standard CAR purchase contract is defaulted for contingency removal within 17 days of acceptance (the date the contract is agreed to, not written). There are several items that the buyer is entitled to “check out” including, disclosures, home owners association documents, appraisal, inspection, and financing. Your agent should be able to help you with this due diligence. Furthermore in California, the contingency removal is by default set for active removal. That means you can not accidentally or inadvertently pass the deadline. Upon expiration of the 17 day contingency period, a form for contingency removal is sent to the buyer for signature. Its not until this form is signed that the buyers deposit becomes “hard” or fully committed to the process. So for 17 days, or what ever time frame is negotiated, the buyer has every right to fully check out the property and his ability to obtain financing before his money is at risk. Once contingencies are removed, failure by the buyer to close the escrow may result in forfeiture of the buyers deposit. There are however many examples where this may not be the case. This is especially true in the event of failure by the seller to disclose or late disclosure of a material fact that could affect the buyers interest in the property. In this circumstance, the buyer may be entitled to an option to cancel the escrow and have his deposit returned. It should be noted however, that this situation might require the assistance of a real estate attorney if contested by the seller.
The bottom line is that if you are making an offer on a house, the bigger the deposit the better (within reason, see table below). It will make your offer stronger than competitors, and your deposit will not be at risk until contingencies are removed. If you perform proper due diligence, the buyers risk will be minimal. To further reduce risk, make the closing of escrow as close to the contingency removal as possible. If they coincide then its possible to reduce your risk as a buyer to almost 0%. Its been my experience that the shorter the escrow, the smoother things will usually go. It seems as if long escrows inadvertently get pushed to the back burner and are fraught with difficulties.
Below are typical deposit amounts:
$3000 to $5000 for condos under $500,000
$5,000 to $10,000 for entry level detached homes under $700,000
$7,000 to $15,000 for homes over $700,000 but under $1 million
$15,000 to $50,000 for homes above $1 million
Please note that this guide is not intended to be specific legal advice and is a generalization for purchase decision making. Please check with your local real estate attorney or real estate professional before making important financial decisions. For further information on buying real estate, visit my web site at http://www.jdanielrealty.com/buyers.php