Can a Seller Keep a Buyer's House Deposit?

Keeping a buyer's deposit could be a legal, yet unwise choice

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Even though a home seller might have a legitimate reason and right to demand a buyer's earnest money deposit in the event a buyer defaults, exercising that right might not be in the seller's best interest.

Emotions and the Transaction

Let's start with the emotional aspects of the transaction. Typically speaking, in any given real estate transaction, it is not the seller who feels wronged during the purchase period. Generally, it is the buyer. The seller is simply hoping the transaction will conclude upon receipt of a huge sum of money deposited into their bank account. The buyer, on the other hand, is suspicious of a rip-off and wonders if the seller is withholding hidden defects.

It is generally the buyer who feels there is more at stake, which tends to add an intense emotional element to the transaction that the seller does not possess, up to the point in time when the buyer cannot close the sale.

The underlying insecurities harbored by the buyer—coupled with the buyer's own smoldering anger over not closing—can develop into an explosive situation, heightened when the seller joins the fireworks by claiming the buyer now owes the seller the earnest money deposit.

The seller can't really force the buyer to close escrow. Many purchase contracts, especially those used in states such as California, contain a liquidated damages clause, which states the seller is only entitled to the earnest money deposit up to a certain percentage of the sales price. Any excess money on deposit is generally returned to the buyer.

How a Buyer Can Get Earnest Money Deposit Refunded

Buyers who are canceling the transaction generally have some sort of contingency period in the contract that gives the buyer the legal right to cancel the contract. It could be a loan contingency, an appraisal contingency, or an inspection contingency. It may be contingent on the buyer selling another home that the buyer can't seem to sell. Many contracts contain contingencies that allow the buyer to cancel under certain circumstances.

Let's say the buyer hires a professional to conduct a home inspection. During the home inspection period, the buyer discovers the furnace is inoperable and the home inspector says the furnace is beyond its useful life. The buyer might ask the seller to replace the furnace. The seller could refuse and tell the buyer to cancel the deal. Under this situation, the buyer might be entitled to receive the earnest money back upon cancellation.

It doesn't mean the seller will want to release the deposit. If the deposit is held by a third party, such as a title company or escrow company, all parties generally need to agree on its disposition or at least agree to cancel. If both parties are unreasonable, the transaction could be placed on hold, depending on state laws. In California, a seller cannot unreasonably withhold a refundable earnest money deposit, or the seller could face a penalty fine.

When the Earnest Money Deposit Is at Risk

Taking the disposition of the earnest money deposit once step further, let's say the buyer has exhausted all contingencies and released all of the contingencies. A few days before closing, perhaps the buyer gets cold feet and decides to cancel. The seller, who might be outraged by this turn of events, would probably have a right to expect to receive the buyer's earnest money deposit since the buyer willfully and deliberately failed to close escrow.

What if the buyer refuses to give the earnest money deposit to the seller? The buyer could make life difficult and refuse to sign any type of cancellation. The seller might be prohibited from selling the property to another buyer while the seller is still under contract with the existing buyer. The seller generally cannot have two contracts at one time, unless one contract is contingent on the cancellation of the other.

Remaining in contract with a stubborn buyer could tie the seller's hands.

Yes, the seller could probably file a case in small claims court and fight the buyer. But even with all the facts seemingly on the seller's side, a judge could still award the money to the buyer. The law is not always black-and-white. How much time and money would be lost trying to obtain the earnest money deposit? If the seller doesn't care how long it takes to sell the home, and is willing to invest time and money to fight for the deposit, then it might be worth pursuing.

This is why a seller should always get legal advice before make a decision about the escrow deposit. A seller can be in the right, yet still lose.