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Dollar LincolnIf you are planning to purchase a home in Silicon Valley, most likely you’ll be working with a real estate professional and together you will use either the California Association of Realtors (CAR) purchase agreement form or the Peninsula Regional Data Source contract (PRDS). Both of them begin with the same basics: who is making the offer, what property is involved, how much is being offered to the home owner and how much is being put down or put into escrow as an initial deposit or good faith deposit.

What is the initial deposit in real estate contracts?

The initial deposit, or good faith deposit, is the amount of money which the buyer puts into the escrow account at the beginning of the transaction. It is usually given in a personal check, which is cashed within a day or two of being brought to the escrow holder (in our area, that’s a title company – in southern California, they tend to use escrow companies or even one of the real estate brokers).  Some home buyers wire in the funds. Either way, unless the boilerplate is changed, the money is due within 3 business days of contract acceptance.

How much is the initial deposit?

In Santa Clara County, or the San Jose area, most often the initial deposit is 3%.  I have occasionally seen offers with as little as 1% (and years ago, as low as $1,000) on them but have not seen sellers want to take those offers.  They want to know that the buyer they get into contract with “has a little skin in the game”.

Why is an initial deposit needed?

The reason for the good good faith deposit is so that you’ve put money at risk should you default. Defaulting is not just leaving with cause during allowed timeframes, but something much worse, leaving after you’ve fully committed (or other breaches of contract).

Why three percent?  The 3% is tied to liquidated damages and the maximum limit for that is 3%.

Some real estate trainers encourage aggressive buyers (or those in multiple offer situations) to put more than 3% down to make the point that they are serious enough to tie up more money in escrow – even if the liquidated damages clause keeps anything over 3% from ever being at risk in case of a default.  It does get the seller’s attention!

Is the initial deposit handled differently if it’s a short sale?

Short sales are mostly a thing of the past here now, but this question arises so let’s talk about it. Usually buyers will not put any money into escrow until there’s bank approval for the short sale (and it’s a sure thing that they CAN buy the house).  But some listing agents are now demanding money in escrow – and also that the buyer have inspections done – prior to bank approval.

My personal opinion is that paying for inspections and appraisals without the lender approval puts the buyer in a terrible position of putting everything at risk (money on inspections, appraisal etc.) without the assurance that the seller will be able to close escrow.  So I would advise against this practice if I were representing the buyer since it’s a potential waste of money.

That said, I completely understand that many short sale sellers have been burned in the past by buyers who put offers on multiple houses at once, which of course is unethical since they were incapable of buying all of them.  The idea was that they’d tie up several homes and the first one with an approval would win.  But by keeping the others knotted up, they literally moved those other sellers closer to foreclosure. Terrible.  So I understand and support putting some money in escrow with short sales.  Often suggested: 1% upfront, 2% more when they get bank approval.  Each sale is different though, so talk with your Realtor about it.