Is the Buyer’s Earnest Money Deposit Refundable in California?

In this article, we will address one of the most common questions among first-time home buyers in California: Is the earnest money deposit refundable?

Here are five things you should know right off the bat:

• Buyers often include earnest money when making an offer on a house.
• This is a common practice in California and most other parts of the U.S.
• The deposit shows that the home buyer is fully committed to the deal.
• The purchase agreement can specify when the deposit is refundable.
• Home buyers can use contract contingencies to protect their deposits.

What Is Earnest Money, Exactly?

When you make an offer on a home in California, you will have the option to put down an earnest money deposit. It serves as a good faith gesture to show the seller you are serious about buying the home.

According to the dictionary, a person who is “earnest” shows sincerity and conviction. And that definition applies to real estate transactions as well.

The deposit amount can vary based on local real estate market conditions and customs. But it’s usually 1% to 3% of the purchase price of the home. If the deal goes through, this money gets applied to the purchase price.

• Earnest money deposit: A small amount paid upfront to show the buyer’s commitment to purchasing the home.
• Down payment: A larger sum paid at closing that goes toward the total cost of the home, as required by the lender.

In some cases, the home buyer’s earnest money deposit is refundable if the buyer backs out. While in other cases it’s not. A lot depends on the wording of the purchase agreement and the inclusion of real estate contingencies.

Deposits Are Optional But Recommended

In California, earnest money deposits are not required by law. There is no rule or requirement that says you have to include a deposit when making an offer to buy a house.

Even so, it’s customary to do so, to the point that sellers usually expect it. Paying earnest money could also give you an added advantage in the real estate market.

California home buyers make earnest money deposits for several reasons:

• First, it shows the seller that the buyer is serious about buying the home. This can help the buyer stand out from others who are making offers on the same home.
• It could also help you secure the home by “shielding” it from those other buyers mentioned above. Once the earnest money deposit has been paid, the seller will be less likely to accept an offer from another buyer.

Situations When the Earnest Money Is Refundable

In California, earnest money is typically refundable if the buyer backs out of the deal for a reason that is allowed under the contract. Some common reasons that allow a buyer to back out include:

• The home does not appraise for the agreed-upon price.
• The home inspection reveals major defects.
• The buyer is unable to obtain financing needed to complete the purchase.
• The seller fails to meet a contractual obligation, like a clear title.

According to the Bay Area law firm SAC Lawyers LLP:

On the other hand, there are some scenarios where the earnest money deposit might not be refundable if the buyer backs out. For example, if the buyer cancels the deal simply because they’ve changed their mind about buying the property, the seller might be able to keep the deposit.

It’s important to read the contract carefully to understand what happens if you back out of the deal. You should also talk to your real estate agent about the benefits and risks of making an earnest money deposit.

The Importance of the Purchase Agreement

The real estate purchase agreement (also known as “the contract”) should clearly state how the deposit money will be held and by whom. It will also outline the conditions under which the earnest money can be refunded.

And this is where “contingencies” come into the picture.

A real estate contract contingency is a clause in a real estate contract that allows one or both parties to back out of the deal if certain conditions are not met. Common contingencies used by home buyers in California include:

• Financing contingency: Allows the buyer to back out of the deal if they are unable to obtain the mortgage financing needed to complete their purchase.
• Appraisal contingency: Allows the buyer to back out (with earnest money intact) if the home appraises for less than the agreed-upon purchase price.
• Inspection contingency: Allows the buyer to cancel the transaction and back out if the home inspection uncovers major defects they are unwilling to accept.

If a home buyer in California cancels the deal for a reason that is covered by one or more contingencies, the earnest money deposit should be refundable. In this case, they should be able to recover the money they paid.

But if the buyer backs out for some reason that’s not included within a contingency, the seller may be able to keep the earnest money deposit.

An Example of a Contract Contingency

In California, contract contingencies can vary from one purchase agreement to the next. They can be worded in different ways to accomplish different objectives. But in many cases, they include boilerplate language where the buyer simply fills in the blanks.

Here’s an example of a mortgage financing contingency that would allow the earnest money deposit to be refunded if the buyer was unable to obtain financing:

The Buyer’s obligation to purchase the Property is contingent upon the Buyer obtaining a mortgage loan in the amount of $[amount] with a term of [number] years at an interest rate not to exceed [percentage] from a qualified lender. The Buyer shall have [number] days from the date of this Agreement to obtain a commitment for such a loan. If the Buyer is unable to obtain a commitment for a loan meeting the terms set forth above, the Buyer may terminate this Agreement by providing written notice to the Seller within [number] days of the expiration of the [number] day period. In the event of such termination, the Buyer shall be entitled to a full refund of the Earnest Money Deposit.

This is just an example, and the specific terms of a contingency will vary depending on the individual circumstances. But this does give you some idea of how these contingencies are worded, and how they can determine whether or not the earnest money deposit is refundable.

Disclaimer: This article is intended for a general audience and might not apply to your particular situation. As a home buyer, the most important thing you can do is carefully read and understand all of the clauses within your purchase agreement. Refer any questions you have to your real estate agent or an attorney.