What should I know about real estate deposits?

Real estate transactions have been happening for almost as long as there has been land. Although the transactions have changed over the years, the basic principles of the trade have remained constant. One of those constants is the real estate deposit, and sometimes the deposit element of the contract can be confusing. Let's take a moment to think clearly about this element of the deal.

What is a real estate deposit for?
When a seller wants to sell a property and a buyer indicates their interest in purchasing the property by writing an offer, the buyer will include a deposit in the transaction terms. This deposit money is designed to signal to the seller that there is a seriousness to the offer that warrants putting up a sum of money for the seller's security, showing the buyer intends to complete the transaction as they said. In Old English, this money is called earnest money because it signals the goodwill of the purchaser towards the seller in their sincere intention to operate in good faith to complete the transaction.

Contract Confusion
In Canada, there are five essential elements that must be present to form an enforceable contract in real estate. These are offer and acceptance, consideration, capacity, consent, and legality. Without doing a deep dive into the meaning of each element, consideration is the one that is often confused in the deposit discussion. Consideration means that for a contract to be enforceable, the seller exchanges something (real estate) for the buyer's consideration (money). In the real estate contract, the deposit or earnest money is NOT that consideration but rather the purchase price is the consideration. Because of this, there is no legal mandate for a deposit. However, it provides a level of security for the seller in getting the buyer to complete the contract. You may be hard-pressed to find a seller unwilling to entertain offers without a deposit.

How much is enough?
A common question is how much deposit is normal on a real estate contract? The simple answer is that there is no simple answer. The deposit money is a term of the contract agreed upon between the buyer and the seller. The more deposit money put forward, the more security the seller gains once conditions have been removed. The deposit money forms part of the purchase price and is calculated as part of the total price offered and not in addition to it. A REALTOR^® can help a buyer navigate the specifics of a transaction to determine how to use the deposit sum as a part of the overall offer strategy.

When is the deposit in jeopardy?
This is a common question of the buyer when making an offer. They want to put their best offer forward but are fearful that the seller may keep their money if they don't continue with the contract. Using the standard AREA purchase contract, there is no mechanism for the seller to keep the deposit of a buyer whose contract has conditions (i.e. financing or inspection) and does not remove those conditions. The deposit money is held under trust conditions by a legal trustee. The standard AREA purchase contract is explicit that the deposit is paid back to the buyer if they end the contract and have not removed their conditions. Alternately, if the buyer decides to remove their conditions and proceed with the contract but subsequently changes their mind, that deposit money is forfeited to the seller, along with other remedies for damages if the buyer does not complete their obligations.

Refunding a deposit to the buyer
The trustee is obligated to follow the rules of trust established in the purchase contract, which should guide the buyer and seller on how the trustee will act in various scenarios. There are key items that should be highlighted. First, the trustee must determine whether the deposit is valid and clear the bank before refunding any deposit money. The refund could take as much as a couple of weeks to be processed. Second, if mom and dad provided the deposit for a child to buy a condo, for example, but that transaction does not go through, the AREA purchase contract indicates the deposit must be refunded to the buyer. That deposit must then be refunded to the named buyer in the transaction and not to mom and dad unless the parties agree to amend the contract.

Deposit vs down payment
In the quick pace of a real estate transaction, sometimes the terms can be confusing for a first-time homebuyer. There is a difference between a deposit and a down payment. Where the buyer is obtaining financing to purchase a property, the lender will inform them of the amount of down payment money they need to qualify for the loan, compared to the amount the lender will finance for them. This is usually represented in a percentage of the total purchase price (i.e. 5% down payment) and is the amount of actual liquid capital the buyer needs to complete the mortgage agreement. The deposit on the contract is also liquid capital provided to the trustee, so whatever amount of deposit indicated in the transaction will be counted by the lender as part of the down payment required and not in addition to it.

Although deposits are only one small part of the real estate transaction process, it is one of the key things that buyers, sellers, and REALTORS^® need to understand to ensure expectations are kept in check. Because the rules of trust are established by the contract, and a trustee is named as well, understanding the contract and clarifying disputes with the trustee are the best way to keep communication lines open on this topic.