What is a deposit?
Updated June 18, 2021
Upon signing a purchase agreement for a home, a buyer will often make a deposit—also called earnest money or a good faith deposit—to demonstrate their seriousness to the seller. The deposit buys the purchaser time to make all the arrangements needed to close on the property, like getting financing and having the home appraised. It can also protect the seller in case the buyer unexpectedly backs out of the deal and the seller has to put their home back on the market.
Deposits are not legal requirements, but they are expected by sellers in many markets.
How deposits are calculated
The amount of the deposit is typically 1% to 3% of the home’s purchase price, and is put into an escrow account until closing. The deposit amount can go up in especially fast-paced markets; a buyer’s real estate agent will advise them as to the appropriate percentage for their situation, or it may be negotiated with the seller.
If the deal goes smoothly, the deposit is returned to the buyer to be put toward the down payment or closing costs. If the deal falls apart due to a problem on the buyer’s end—like they fail to meet all the closing requirements on the timeline specified by the contract—they forfeit the deposit and the seller keeps the money. On the other hand, if the deal falls apart due to issues on the seller’s end—like a failed home inspection—the deposit is returned to the buyer. Buyers can ensure they get their deposit back in such a situation by including contingencies in their contracts that cover issues like home inspections that find major problems.
Sometimes you can get your deposit back, but other times you'll have to forfeit it. A contingency can protect buyers from losing out. Credit: Andre Taissin/Unsplash
The good news for buyers is that deposits earn interest, so should the deal fall through, they will earn some money for their trouble. Note that if interest on a deposit exceeds $600, buyers need to report it to the IRS.
Deposits and contingencies
Covering various contingencies in a contract is the best way for buyers to ensure they get back their deposits if a deal falls through.
A home inspection contingency, for instance, will protect buyers in the event that an inspection turns up a major defect in a home, and they decide not to buy. Appraisal contingencies allow buyers to back out of deals if an appraiser determines a home is worth less than its sales price. Mortgage contingencies protect buyers who run into problems getting financing and need to walk away from purchasing a property. Finally, existing-home sales contingencies protect buyers who are unable to sell their homes in time to purchase a new one and therefore need to terminate a deal. If any of these issues arise and a buyer’s contract includes these contingencies, they can cancel their planned home purchase and get their deposit returned.
In especially competitive markets, buyers sometimes waive contingencies in order to have an edge and appeal to sellers. Buyers should only do this if they can afford to lose their deposits should a deal go sour.
Deposits on rentals
On the rental side, most landlords require tenants put down a security deposit before they move in. This deposit is intended to protect the landlord should the tenant damage the apartment, fail to pay rent, or break their lease early. When the tenant moves out, the landlord will inspect the apartment and determine how much of their security deposit will be returned, subtracting the cost of any necessary repairs.
The law varies as to how much the landlord can collect in security. In New York, for instance, rent reform legislation passed in 2019 limits landlords to collecting one month of rent as a security deposit. Moreover, New York landlords must put the deposit in an interest-bearing account. Landlords are technically required to return to tenants the full annual interest, less 1% of the security deposit per year, but in most cases interest rates are so low that tenants don’t end up collecting the money.
Elsewhere, landlords can collect more in security, but most states impose limits.