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When Can a Seller Keep the Earnest Money Deposit in California?

In a previous article, we explored some of the scenarios where a home buyer in California could recover their earnest money when backing out of a real estate transaction.

In this article we’ll look at the flip side, when a seller might actually be able to keep the buyer’s earnest money deposit. Home buyers in California need to understand both sides of this issue so they can make informed choices and protect their investment.

How Earnest Money Works in California

In a typical real estate transaction, the buyer and seller will agree on a price and sign a purchase agreement. After that, the buyer submits their earnest money deposit. This deposit is usually held in escrow by a neutral third-party, until the transaction either closes or falls through.

In California, the earnest money is usually held by an “escrow agent” who works for a title or escrow company. Eventually, the escrow agent will disburse the earnest money to the appropriate parties based on the outcome of the transaction.

  • If the deal succeeds, the deposit should be applied to the home buyer’s closing costs or down payment at closing.
  • But if the deal falls through, the fate of the earnest money deposit will depend on the reason for that outcome and the wording of the contract.

In California, purchase agreements sometimes include contingencies that protect the buyer’s interests and the earnest money. A contingency is a specific condition that has to be met in order for the deal to proceed.

Some of the most common contingencies include:

  • Inspection contingency: Allows the buyer to inspect the property and back out of the deal if significant issues are discovered.
  • Appraisal contingency: Protects the buyer if the property doesn’t appraise for the agreed-upon purchase price.
  • Loan contingency: Allows the buyer to cancel the contract if they are unable to secure mortgage financing to complete the purchase.

These contingencies give home buyers time to complete the necessary steps and to ensure that the property meets their expectations.

If the buyer cancels the contract within the contingency periods—and for a reason that’s covered by a contingency—they’re generally entitled to a full refund of their earnest money.

But it doesn’t always work out that way. So let’s look at the flip side…

Scenarios Where the Seller Could Keep the Deposit

As a home buyer, you should also know there are times when a seller could keep the earnest money deposit. These scenarios represent a kind of last resort for the buyer, since it could result in the loss of funds.

If a home buyer backs out of a deal, the seller essentially suffers a setback. By taking their home off the market for one person, the seller could miss out on the opportunity to secure other offers. The earnest money deposit can compensate the seller in such situations.

Here are some scenarios where a home seller in California might be able to keep the earnest money when a deal falls through:

  1. Buyer defaults after contingency period. If the buyer backs out of the deal after the contingency period has expired without a valid reason covered by a contingency, the seller may be entitled to keep the earnest money as liquidated damages.
  2. Buyer fails to close on time. If the purchase agreement specifies a “time is of the essence” clause, and the buyer fails to close by the agreed-upon date without a valid reason, the seller may be able to retain the earnest money.
  3. Buyer fails to meet the conditions of the contract. If the buyer fails to fulfill any of their obligations under the purchase agreement, such as obtaining financing or providing necessary documentation, the seller may have the right to keep the earnest money.
  4. Buyer has a change of heart regarding the home. If the buyer backs out of the deal just because they’ve changed their mind about purchasing the house (and there’s no contingency to cover it), they might lose the deposit.

But even in these scenarios, the seller might not automatically be entitled to keep the full earnest money. The amount that they can retain could be limited by law.

In California, for example, the amount the seller can keep is typically capped at 3% of the purchase price. Anything above that amount must be returned to the buyer. This is usually how it works, but the situation can vary based on the wording of the contract.

The Good News: Most Home Sales Succeed!

Let’s end on a positive note, shall we?

While it’s important to understand how earnest money works, including the scenarios where the seller might keep it, the truth is that most real estate transactions succeed.

An analysis conducted by Trulia a few years ago found that 96% of home purchase transactions succeeded, while only around 4% failed to reach the final closing. This should give home buyers more confidence when it comes to navigating the offer and escrow part of the process.

Even so, buyers should carefully consider the contingencies they add to their purchase agreements and understand how it might affect their earnest money.

Disclaimer: Real estate transactions can vary due to a number of factors, including the specific clauses contained within the purchase agreement. As a result, your experience may differ from the scenarios presented above. This article is not meant to take the place of legal advice.

Mike Trejo is a Bay Area mortgage broker with 20+ years of knowledge and experience.

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