Negotiating a Sales Agreement: The Deposit
The deposit is a part of the negotiations since it indicates the depth of the buyer’s sincerity in making the deal. The buyer is presumably sincere, hence the correct term, earnest money deposit. However, there is no reason why a deal cannot be completed without a deposit. But a buyer who does not put up a deposit is suggesting that he or she has little financial commitment to the purchase. A seller is far less inclined to look favorably on an offer without a deposit.
If the deal falls through because of a fault of the buyer (for example, the buyer simply refuses to go forward and buy the property), then presumably the seller is entitled to the deposit. If the deal collapses through no fault of the buyer (for example, the seller can’t give clear title), then the buyer is presumably entitled to a full refund.
If you’re a buyer, be sure that the fact that the deposit is to be used as part of the down payment is specified in any sales agreement you sign, or else the deposit could be interpreted to be in addition to the down payment!
From the seller’s perspective, the buyer is presumably putting up money that will be lost if that buyer fails to complete the purchase.
It’s money at risk. Hence, if the buyer puts up $10,000, it presumably shows that the buyer is quite enthusiastic about the property and committed to the purchase.
Who Gets the Deposit?
Consider Sally, who wants to buy a home and puts up a $5,000 deposit. As soon as the seller, John, accepts the offer, he is entitled to that money. It should be paid directly to him. Later, if the deal doesn’t go through due to a fault of John’s, then it’s up to Sally to get the deposit back from John.
However, if John isn’t entirely scrupulous or just not very good at handling money, he may not want or be able to pay Sally back. Sally eventually might need to go to court and sue John for the recovery. The trouble is, of course, that the suit could cost more than the amount of the deposit to be recovered!
As you can see, this could be a messy business. It’s a poor way to handle a deposit. Further, if an agent were involved, chances are that both Sally and John would blame that poor soul for what happened in the deal and insist that the agent come up with the money.
More than anyone else, agents who are involved with deposits on a day-to-day basis realize the problems and potential pitfalls involved with giving the deposit to the seller. Therefore, most agents suggest that the buyer make the deposit to a third party. One choice is the agent, who can then keep it in a trust account. The trouble with this is that if the agent is the fiduciary of the seller and the seller insists on getting the deposit, the agent could feel obligated to turn it over . . . and then answer to the buyer about where the money went. This puts the agent in an even worse position.
Therefore, today most agents insist that the buyer make the deposit check to an escrow company. If the offer is accepted, the check is immediately deposited into escrow and there it sits until the deal is concluded . . . or later.
The “Or Later” Problem.
If the deal isn’t concluded for any rea son, that deposit usually continues to sit in the escrow account. The buyer can’t get it back unless the seller signs off. The seller can’t get it unless the buyer signs off. In actual practice, however, the seller may have difficulty in reselling to someone else with a deposit check from a previous buyer hanging over his head in escrow, so he may sign off simply to be done with the old deal. As a result, the buyer may get the deposit back, sooner or later.
Buyer or seller can go to court and sue the other party to get the deposit check released out of escrow. But in residential real estate, the deposits are usually too small to warrant such expensive action. It’s simpler to just settle.
A settlement regarding who gets the deposit when a deal goes sour is negotiable. While most often the buyer gets it all back (real estate agents prefer this because it tends to help their reputations and avoid malpractice lawsuits against them), it doesn’t have to be the case. The seller could get it all, or it could be split.
Sometimes a clever buyer will include a clause in the agreement to the effect that if the deal isn’t concluded within 120 days, for whatever reason, any money the buyer deposited into escrow automatically reverts back to the buyer. Some sellers will agree to this, thinking that this is a clause whose intent is to encourage the seller to move the deal along, not realizing that what it really means is that all the buyer has to do is procrastinate to get that deposit back. Savvy sellers often will balk at such a contingency.
Failure to Complete the Transaction
Thus far, our assumption has been that the deposit is all that’s at stake. However, if a buyer fails to go through with a deal without having a valid reason for backing out, the seller might take the buyer to court for failure to complete the deal according to the sales agreement and potentially get a settlement and damages.
The Deposit as Liquidated Damages
This is a real risk for buyers. It is also a particular risk for agents, who usually get thrust into the middle of such angry actions. Therefore, today many agents include in their sales agreements a clause that specifies, that in the event the buyer does not go through with the sale and has no legitimate reason for backing out, the deposit is automatically to be considered liquidated damages. In other words, the seller gets the money, and in many cases cannot sue for additional damages.
As a buyer you have the option of agreeing or not agreeing with this condition. It’s something you should consider and discuss with your attorney.
What Is the True Effect of the Deposit?
Realistically, in residential real estate today, the deposit has the same function it always had—to demonstrate how sincere the buyer is. However, what it really means is that the buyer is willing to tie up a set amount of money for a period of time. Any anticipation by the seller that he or she is going to be getting that money any time soon without a sale may be more wishful thinking than anything else.
How Big Should the Deposit Be?
As far as most sellers are concerned, the bigger the deposit, the better. However, after a certain point, additional amounts of money aren’t going to tilt anyone’s head. Remember, any realistic seller today knows that the chances of ever getting that deposit if the deal sours may be remote.
Further, in today’s transactions, there are really two parts to the deal. The first is when the sales agreement is signed all around. The second is when all of the buyer’s contingencies have been removed. (These are such things as giving approval to an inspection report or seller’s disclosures, which, until done, allow the buyer to withdraw from the deal without penalty.) Until the contingencies have been removed, the size of the deposit is mostly moot. After all, if the buyer can easily back out, who cares if it’s $5,000 or $50,000?
On the other hand, once all of the buyer’s contingencies are removed, it’s far harder for him or her to back out of the deal with out losing the deposit. Thus, the size now becomes very important.
Therefore, savvy sellers will often insist that after all contingencies are removed, the buyer increase the size of the deposit. This helps assure the seller that the buyer will, indeed, move forward with the purchase.
Sometimes a buyer who has a particularly poor offer will submit a very large deposit. The hope is that the seller will focus on the deposit and not on the deal. ” Very few sellers are sonaive today.