RealAnswers

Alison writes in with a great question, “What proportion of the value of the property would a back-up contract typically involve as a deposit?” To answer this one, I’m going to start by looking at how much is an appropriate earnest money deposit in a “normal” contract and then consider backup contracts.

First, a deposit, often called “earnest money”, is simply the money that a buyer puts up at the time an offer is made to show good faith, in other words to show that the offer is made “in earnest.” If the offer is not accepted, it is refunded. If it is accepted, the earnest money is held in escrow until the deal closes. If the buyer acts in good faith under the terms of the offer and agreement (the contract) and the deal fails to close through no fault of the buyer, the money is refunded. A quick example – if there is an inspection clause and the inspection turns up major problems that the seller is unwilling to correct, the buyer can typically void the contract and get the earnest money back. A counter-example – the buyers are engaged, the wedding is called off and neither buyer can afford the house alone. In that case, the buyers are typically still obligated to purchase the house or forfeit the deposit. Of course, all of this depends on the terms of the contract and your local laws, so when it comes to actually determining who gets the earnest money in a failed deal, a lawyer’s advice may be your best bet.

So, what’s an appropriate earnest money deposit? There are several answers:

• Everything is negotiable. If the seller thinks the deposit is too low, he can ask for a bigger deposit in a counteroffer.
• 1% of the purchase price is typical in many areas.
• $500 to $1000 is typical in many lower cost areas, even though this may sometimes be more than 1%.
• 3%, the down payment on many low down loans, is not unheard of
  many areas. Some REO sellers (banks and mortgage companies that own foreclosed properties) insist on this much.
• No deposit is technically required at all, but any seller would be stupid to tie up a property without one.
• An in-kind deposit or promissory note are both possible.

The real answer is that earnest money deposits vary by your local custom, the type and value of the property and, ultimately, what the seller is willing to accept.

An important thing to note is the effect of the earnest money on the seller’s attitude. A small earnest money that makes the seller take the offer less seriously could end up meaning a higher purchase price if the seller doesn’t negotiate as seriously. Saving a few hundred dollars on a deposit that will be held for 30-60 days and is still your money, only to end up paying thousands more on the actual purchase price is definitely not worth it. Your best guide in this will be a discussion with your exclusive buyer’s agent whose job is to look out for all your interests – making sure you don’t put up too little and miss out on the deal or put up too much.

So, what about the case of a backup contract? The deposit on a backup contract when it becomes primary should be just as large as for any other primary contract. Understandably a buyer may not want to put up as much deposit for a backup contract initially, since the deal is less likely to ever close. One way I’ve seen this dealt with was for the buyer to offer a token deposit ($100-500) at the time of the backup offer with the agreement that when the contract becomes primary the deposit will be increased to an amount more typical for the area.