Prospective buyers often will include a deposit in their offer to purchase to indicate their sincerity in closing the deal. In Old English, this payment is called earnest money because it signals the goodwill of the purchaser toward the seller to operate in good faith to complete the transaction. The deposit forms part of the agreement and is applied against the buyer’s down payment at closing.
When a buyer’s offer to purchase is drawn up by legal counsel it will include conditions that have to be met before it is officially binding. Common examples of the types of conditions include:
- a satisfactory home inspection;
- financing approval;
- the seller obtaining another property; and
- the buyer receiving an offer of purchase on their home.
If any condition in the offer to purchase is not met, the deal could fail and is no longer binding on either party. In most cases, the deposit will be returned to the buyer and the seller is then able to receive and accept new offers again on the property.
Five essential elements in a contract
According to the Alberta Real Estate Association (AREA), there are five essential elements that must be present to form an enforceable contract in real estate. They are:
- offer and acceptance;
- consideration;
- capacity;
- consent; and
- legality.
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,” AREA states. “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.”
This situation can put buyers in a tough situation. They want to put forward an offer that will interest the buyer but they may also be fearful they could lose their deposit if the deal falls through.
The Association offers advice to people in that situation.
“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 Association states. “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.”
How the refund is made
The rules of trust established in the purchase contract guide the buyer and seller on how the trustee will act in various scenarios. For example, the trustee must determine whether the deposit is valid and has been cleared by the bank before refunding any deposit money. The refund could take weeks to be processed.
If parents provide money for one of their children to put a deposit down on a condo 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,” the Association states.
A deposit is not a down payment
Some first-time homebuyers are confused about the difference between a deposit and a down payment.
As explained above, a deposit is a sum of money held by a trustee when a buyer makes a purchase offer to show the buyer is serious about the offer. Deposits are usually in the form of a bank transfer or certified cheque. Unlike the down payment, the deposit is not a fixed percentage of the purchase price and can range from two to 10 per cent of the property’s worth, depending on the local real estate market and the property’s value.
The deposit is payable immediately after an offer is accepted. It is given to the real estate company that listed the property and is held in a trust account until the buyer takes possession.
The down payment is made after the offer has been accepted. It is typically paid at the closing of the sale with the remaining balance covered by a mortgage loan. The percentage required for a down payment is a minimum five per cent of the property’s value and it can go up from there depending on several factors, including the lender’s requirements, the type of loan and the buyer’s financial situation.
When deposits are refunded to the buyer
According to AREA there are four common scenarios when deposits are refunded to the buyer. They are:
- If conditions in the sales agreement are not met by the seller.
- If the seller is unable to produce confirmation that a non-owner spouse is willing to allow the transaction, the buyer has a way out by voiding the contract after the date specified in the Dower section of the agreement, which is meant to protect spouses in a marriage. Read more about the Dower Act here.
- If the buyer fails to pay an additional deposit anticipated in the contract and the seller chooses to exercise their void option, all previous deposits are paid to the buyer because the seller ended the contract at their will.
- If the seller fails to perform conditions of the contract the deposits are restored to the buyer since the seller did not fulfill their end of the agreement.
When buyers can lose a deposit
Generally speaking, the only time buyers can lose a deposit is if they remove conditions on their offer and do not take possession of the property as agreed in their contract. However, if they have a condition stating that they must be approved for financing, but that does not happen, they will not lose their deposit. In that scenario, they must have their financial institution provide a letter to the seller and their agent stating they are not approved for financing.
Contact us for assistance
Putting down a deposit is an important first step in a first-time homebuyer’s path to home ownership. It seems simple but as with everything associated with real estate, prospective buyers need to seek the advice of knowledgeable legal counsel before inking a deal. Demas Schaefer Real Estate Lawyers serve all of northern Alberta. Contact us for a free consultation.