WRITTEN BY JOHN REILLY
Deposit vs. Down payment
Even though the down payment usually includes the earnest money deposit, the terms are not synonymous. Earnest money is applied toward the total amount of cash down payment due at the closing.
Money offered by a prospective buyer as an indication of good faith in entering into a contract to purchase; earnest money; security for the buyer’s performance of a contract. An earnest money deposit is not necessary to create a valid purchase contract because the mutual promises of the parties to buy and to sell are sufficient consideration to enforce the contract. If the buyer completes the purchase, the deposit money is applied toward the purchase price. If the buyer defaults, the contract may provide that the seller can retain the deposit money as liquidated damages.
Contracts also often require the seller to split the deposit money with the broker, up to an amount not exceeding the broker’s commission (per the terms of the listing or the contract of sale). If the seller defaults, the deposit should be returned in full to the buyer.
For protection, the seller should require a deposit large enough to cover the broker’s commission, the cost of the title search and the loss of time and opportunity to sell elsewhere. A deposit of 10 percent of the purchase price should be adequate. If the seller requires too substantial a deposit, however, a defaulting buyer might seek a return of part of it, claiming that the deposit did not accurately serve as liquidated damages, but rather as a forfeiture or penalty. Some states set a standard such as 3 percent; if the deposit exceeds that amount, the seller has the burden of proving that the deposit was, in fact, reasonable and not a penalty.
If the deposit involves a large amount of money, it is good practice to provide that the deposit be placed in an interest-bearing account for the buyer’s benefit.
The buyer should be careful to ensure that funds are sufficient to cover the deposit check. If the deposit check bounces, the seller could try to terminate the contract by arguing that no valid contract exists, as the seller’s acceptance is conditional on receiving a proper deposit.
The question of who owns the deposit sometimes arises. If the seller authorizes the broker to accept deposit money on his or her behalf, the deposit money belongs to the seller when the broker accepts it. In some states, the deposit money must be placed in a neutral escrow and cannot be withdrawn until the transaction is consummated.
It never belongs to the broker, although the broker may share in the deposit money if the buyer defaults and the seller retains the deposit as liquidated damages. In a case where the broker absconds with the deposit money, if the seller has not authorized the broker to accept the deposit money the broker is acting as the buyer’s agent in handling the money until such time as the seller accepts the buyer’s offer to purchase. Thus the buyer would suffer the loss if the broker were to steal the money. On the other hand, if the seller had authorized the broker to accept the deposit, the seller would suffer the loss. Such authorization is specifically contained in many exclusive-right-to-sell listing contracts.
The amount of cash a purchaser will pay at the time of purchase. Even though down payment usually includes the earnest money deposit, the terms are not synonymous. Earnest money is applied toward the total amount of cash down payment due at the closing.