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. This article answers some of the most common questions on this subject, including the minimum earnest money deposit for California.
What Is an Earnest Money Deposit?
So what does it mean to be earnest, and what the heck 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 home buyers as well.
An earnest money deposit is a way to demonstrate that you are serious and sincere about buying a house. It’s a show of “good faith” in your intent to purchase the seller’s home.
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 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 — as opposed to someone who is going to waste their time.
What’s the Minimum 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 $300,000, he or she might make an initial deposit somewhere between $3,000 and $9,000. Or less, depending on what is customary in that area.
In a less competitive market (where there are plenty of homes for sale but limited demand from buyers), a flat amount might be used for earnest money deposits. For example, it might be customary for buyers to make a deposit of $1,000 — regardless of the purchase price. So the minimum earnest money deposit in California can vary depending on where you are buying, and how much competition there is.
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.
Bottom line: When it comes to the amount of earnest money needed in California, home buyers would be wise to (A) follow local norms and (B) look to their real estate agents for advice.
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 home buyers in California make an earnest money deposit, 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 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 cost associated with the purchase). This is typically how it works.
You can get a better understand 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. Under section 3 of this document, we find some fill-in-the-blank portions that relate to the buyer’s “initial deposit,” which is the earnest money. Click the image below to see more.
Image: Screenshot of a standard purchase agreement. Click to enlarge.