How Earnest Money Deposits Work in California: A Buyer’s Guide

If you’re buying a home in California sometime soon, you’ll likely have to deal with the earnest money deposit. This is a “good faith” showing that tells the seller you are serious about buying the property.

But we know from experience that first-time home buyers in California have a lot of questions about these deposits. We’ll be answering most of those questions in this helpful guide.

What Is an Earnest Money Deposit?

So what does it mean to be earnest, exactly, and what does it have to do with real estate?

According to the Collins Dictionary: “Earnest people are very serious and sincere in what they say or do, because they think that their actions and beliefs are important.” This definition can be applied to California home buyers as well.

To better understand the need for earnest money deposits in California, you have to put yourself in the seller’s shoes.

It takes a lot of effort to sell a house. There’s the market research, the planning and pricing, the constant cleaning and staging. It can be a real disruption in a person’s life.

As a result, sellers want to make sure they are dealing with serious buyers, someone who is willing to invest in the purchase right up front. And that’s exactly what the earnest money deposit demonstrates — sincerity.

How it Fits Into the Home Buying Process

This will make more sense if we zoom out and look at the broader home buying process, and how earnest money fits into it.

The home buying process in California can vary from one buyer to the next. But it usually includes the following steps in this order:

1. You find a home you like and decide to make an offer to buy it.
2. Your agent helps you prepare a purchase offer with the price and other terms.
3. You submit your offer to the seller, indicating an earnest money deposit of X%.
4. You deliver your earnest money deposit check to an escrow company.
5. The escrow company holds the deposit in a special account until closing day.
6. At closing, your deposit will be applied toward the down payment or closing costs.
7. You can then complete the closing process and get the keys to your new house.

How to Protect Your Deposit Money

As a home buyer, you can protect your earnest money deposit from forfeit by including certain contingencies within your contract. A “contingency” is a specific condition that must be met in order for the deal to move forward.

Note the difference in the following scenarios.

• Without contingency: If a buyer backs out of a deal for no reason other than changing their mind, they risk losing their earnest money deposit. The seller might be able to keep it.
• With contingency: If a buyer backs out due to a reason that’s clearly stated within the contract, such as an unsatisfactory inspection, they should be able to recover the earnest money.

In short, the use of contract contingencies can determine whether or not a home buyer in California keeps or forfeits the deposit, if they exit the transaction.

The Good News: Most Deals Go Through

But don’t let any of this scare you away from buying a home. The truth is that most real estate transactions in California successfully reach the closing. Contract disputes and similar issues are a rare occurrence.

A few years ago, researchers from Trulia found that 96% of home purchases succeeded, while only 4% failed to reach closing. That’s an excellent success rate.

Even so, California home buyers should enter the process armed with knowledge and understanding, especially when it comes to the earnest money deposit. And that is our purpose here today!

What’s a Typical Deposit Amount in California?

There is no law that dictates the minimum earnest money deposit in California. It’s more a matter of custom and common practice. So the “standard” amount can vary from one real estate market to the next.

The deposit amount is usually determined as a percentage of the purchase price. In California, a typical or average earnest money deposit might range from 1% to 3% of the purchase price.

For example, if a buyer is offering to purchase a home for $700,000, he or she might make an initial deposit somewhere between $7,000 and $21,000. Or maybe less, depending on what is customary in the local market.

As a general rule, buyers tend to put down more money in a more competitive market. So the amount of earnest money needed to make an impression in San Jose or San Francisco might be much higher than it is in Bakersfield or Fresno. It can vary from one real estate market to the next, because there are no set rules.

What Happens to the Money at Closing?

In a financial context, a “deposit” is an advanced payment that goes toward the overall purchase price. This is how it works in real estate as well.

When California home buyers make an earnest money deposit up front, they are essentially prepaying some of the purchase price prior to completing the sale.

The funds provided by the buyer are usually held in an escrow account that’s managed by a neutral title company or real estate agent. As the transaction moves forward, the deposited amount is then applied to the buyer’s down payment at closing (or other costs associated with the purchase).

You can gain a better understanding of how earnest money deposits work by reviewing the California Residential Purchase Agreement. This is the standard document used for home purchases in the state. You can find a blank PDF version online.

Under section 3 of this document, you’ll notice some fill-in-the-blank portions that relate to the buyer’s “initial deposit.” That’s where the buyer indicates the earnest money amount.

Five Key Takeaways From This Guide

Here are the most important points you should take away from this guide:

• Home buyers make earnest money deposits to show that they are serious about buying the house.
• In California, earnest money deposits typically range from 1% to 3% of the purchase price.
• The money is usually held in an escrow account by a neutral third party, such as an escrow or title company.
• During the closing process, the deposit will be applied to the purchase price.
• Home buyers can add contingencies to their contracts to protect their earnest money if they exit the deal.