The Good Faith Deposit for Real Estate

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A search I just noticed asked the question "Who gets the deposit if escrow falls through?"

The theory of the deposit is that here is an amount of cash that the buyer is putting up as evidence of their ability and intention to consummate the transaction.

This is a good question. I've only dealt with real estate sales in California, so I'm going to deal with it from a California perspective. California is a widespread model for real estate practices (as New York is for insurance), but I can't speak to the specifics which states are and aren't following this model and to what degree.

Most of what happens in real estate sales contracts has a default way of handling it, but is subject to specific negotiation. In other words, there's a standard way of doing it, but you can change that by negotiation with the other party. California Association of Realtors (CAR) has a specific set of forms that are encouraged, in order to make these questions somewhat more clear cut.

The standard here in California is that the purchase is contingent for seventeen calendar days, after which the buyer's deposit will belong to the seller whether escrow closes or not. From the time the contract is accepted by both sides, the buyer has seventeen days to finish all inspections, and to obtain a commitment for acceptable financing. If they call it off within those seventeen days, they get the deposit back. If the purchase falls through later than the seventeen days, the seller is usually entitled to the deposit, within limits. The seller can't just arbitrarily cancel the transaction on the eighteenth day and keep the deposit. The time specified in the purchase contract has to have expired, there must be evidence of bad faith dealing on the buyer's behalf - something.

Let me make very clear that the seller is indeed giving the buyer something when the purchase contract is signed. To be precise, the exclusive right to purchase that property for a certain amount of time. There are expenses of selling that they must pay and that they don't get back if the buyer can't carry through, not to mention expenses related to preparing to move, at least potentially having the house sit vacant, etcetera. They cannot conclude a purchase contract with anyone else while the current buyer's contract is going on. If I'm selling, I insist upon retaining the deposit if the buyer can't carry though. If I were to be unable to consummate a purchase, I certainly understand that the seller will retain the deposit in most circumstances.

The escrow company won't just give the deposit to the seller. They are paid to be a neutral third party, to stand in the middle and make sure that everybody gets what everybody agreed upon, but it is not their place to settle a dispute. For that, you're going to have to go through whatever dispute resolution process is appropriate. This can be mediation, arbitration, the courts, or possibly something else. You can spend a lot of money fighting what the contract says, but in the end you can also expect to have to live up to it, and likely to pay the other party's costs as well as your own, so better not to fight something the contract says you should have done. The escrow company will often also charge a cancellation fee from out of the deposit, by the way. They do an awful lot of work, and if the transaction gets canceled for whatever reason, they do not otherwise get paid.

The number one reason for failed escrow is loan providers leading borrowers down the primrose path. "I can do that," and no, they can't. Unfortunately, I've never seen anyone able to recover damages from a failed loan provider. I used to advise people to get back up loans, but due to changes in the loan market, nobody can offer those any longer. For sellers, look for a qualification letter that you can take to any loan provider to find out if this buyer is qualified.

You can change the standard contract by specific negotiation. If you're a seller who wants to get the deposit no matter what on day 30, you can ask for that as a condition of the initial sales contract. In a hot market, this is easy to ask for and get, but in a buyer's market, you are likely to lose the buyer. If you're a buyer who doesn't want to lose the deposit no matter what, you can ask to put that into the contract you propose, but most sellers, even in a buyer's market, are going to tell you to take a hike somewhere else. No big deal if it was "Hey, let's make a bid on this and see how desperate they are!" A real problem if you fell in love with the property and just have to have it. Over-playing your hand in negotiations is as disastrous as under-playing, and I've seen many people so intent on being Mr. Tough Negotiator that they diddled themselves out of an excellent transaction. In any case, being too sticky on the deposit is a good way not to get as good of a price as you otherwise might have. For a seller, you have this property and you want cash. You need somebody to agree to pay it - the cash is not going to materialize out of thin air. For a buyer, the whole idea is that this property is attractive to you for some reason, or you would not be making an offer. You are asking the seller to trust thousands of dollars to your ability to swing the deal as much as you are trusting their ability to deliver a clear title to a property without hidden defects.

Whether you are a buyer or a seller, once that contract is signed, you want to get cracking on whatever your obligations under it are. Get it Done. Prompt good faith execution of everything you need to do to make the contract happen is your best protection against losing the deposit if the transaction fails. The alternative is that you're likely to forfeit whatever rights to the deposit you may have had if you had been prompt. Just because Things Take Time in Real Estate Transactions is no excuse for you to waste time. Wasting time is expensive for everyone, and one of the strongest signs of a sour transaction I know. Buyers and borrowers pay increased loan and other costs, sellers lose money from delay. This is equally true in refinancing, by the way. The loan you are quoted today does not exist tomorrow unless you act on it today. In summer 2003, when rates hit what were at the time fifty year lows, many people were in no hurry, and rates shot up a full percent and a half over a couple weeks. Today, rates have been even lower for years, but they've been slowly climbing these last several months, and you can see signs that they're going to rise further even if the economy dies completely. But many people insisted upon thinking, in the face of evidence and testimony to the contrary, that the rates would always be there, and they lost out. This happens constantly on smaller scales, and recently happened again on a bigger one. If rates go down after locking, a good broker may be able to get you better rates. If they go up, you've got the lock. If rates go up and you didn't lock, you get the higher rates. Period.

But the deposit is definitely something that the buyer can owe the seller if the transaction falls through, and that's as it should be.

Caveat Emptor

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2 Comments

Larry Loftis said:

Hey thanks... good stuff!

We just had an escrow cancelled. The offer was accepted on 2/24 and cancelled on 3/13. Looks like they made the 17 day test?

We still would like to keep the deposit for the following reasons:

1. This offer came in knowing we were counter-offering another buyer - he's now gone.

2. We were off the market during a good time for the escrow period.

3. After Home Inspection the buyer came back asking for a cash allowance of $8500 for work we had completed for $3,500. Plus he asked for new roofs on all the buildings even though inspection did not cite roof in need of repairs (another $10,000 allowance). He also requested I drywall the interior of garage (never mentioned in HO Inspection report). Stuff like that... I responded as I was carring the paper (owner financing), there would be no cash discounts as I have a vested interest in the repairs being finished professionally and timely. His response was to send over a cancellation form.

4. We initated repairs immediately and have spent over $4K.

5. His broker told me (in an email) his buyer cancelled because he decided he would rather buy something bordering BLM land.

I don't think I can dispute the 17 day rule, but he certainly cost me money, market timing and a real customer. I feel he entered escrow in bad faith. Does not have a valid reason for cancelling and should give up the deposit.

One last quick point....

After escrow opened, he wrote an addendum changing the financing to "interest only"... which I rejected. He never furnished any requested tax returns, etc.

So can I keep this jerk's crummy $2K deposit as liquidated damages?

Thanks Again,
Larry

Dan Melson said:

You certainly have an excellent case. Unfortunately, it's not up to me or the escrow company.

In any case, I'd say you're better off without this buyer.

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About this Entry

This page contains a single entry by Dan Melson published on March 6, 2020 7:00 AM.

Why Renting Really Is For Suckers (And What To Do About It) was the previous entry in this blog.

Who Has An Interest That Should Be Protected In A Real Estate Transaction? is the next entry in this blog.

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