What is the earnest money deposit in a real estate transaction?
First-time homebuyers know that they’ll need a down payment if they hope to get a loan.
What they often don’t know is that they will also need cash to use as what is known as an “earnest money deposit” to submit with the offer to purchase when they find the home they want.
This deposit takes its name from its purpose: It shows the sellers that you are earnest about following through with the transaction to purchase the home – you are, in essence, “putting some skin in the game.”
Although the amount of the deposit isn’t set by law, it varies according to region and the real estate customs within that region.
Something called “liquidated damages” typically determines how much a savvy listing agent will counsel her clients to demand.
Buried within most pre-printed real estate purchase agreements is a clause known as “Liquidated Damages.” This concept is defined well by Bob Hunt at RealtyTimes:
“A liquidated damages clause sets in advance – at the time of contract formation – what the monetary value of damages shall be in the event of contract breach by one of the parties.”
In other words, should the buyer fail to hold up her end of the bargain, the seller agrees not to sue but to keep whatever amount of money the parties have determined will cover damages.
The amount of liquidated damages is stated as a percentage. In California for instance, that amount in most cases is 3 percent of the sales price of the home.
So, what do liquidated damages have to do with your earnest money deposit? If you default on the purchase of the home, this deposit may be forfeited as liquidated damages.
The liquidated damages clause must be initialed by both parties to be valid and the release of the money must be agreed to as well. Then, there is the issue of trying to prove that you suffered damages.
The amount of earnest money you’ll need to deposit will vary by region and also by homeowner dictates. One percent of the purchase price is standard in Northern California but the buyer is typically asked to increase the deposit after the removal of contingencies.
As mentioned earlier, smart listing agents will counsel their clients to ask for an increase that will make the deposit equal to the maximum amount of liquidated damages.
Like many aspects of the residential purchase agreement, the amount of earnest money to deposit is negotiable so – whether you are the buyer or the seller — ensure that you’ve hired a knowledgeable real estate agent that can counsel you wisely.
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