How Do Deposits Work?
When making an offer for land, the Letter of Intent contains the price being offered and other proposed essential terms and conditions. And one of these key terms, which will eventually become part of the binding purchase contract, is the amount of good faith deposit from the buyer and the terms associated.
In most land transactions, the buyer will typically offer and negotiate a feasibility period to analyze and vet out all issues. During this period, which typically varies from 30 to 90 days depending on the complexity of the project, the deposits are usually refundable if the buyer decides to back out of the deal. At the end of this feasibility period, the deposit will become non-refundable if the buyer elects to move forward with the transaction.
For a seller, the amount of this deposit is more important with respect to when it becomes non-refundable. As example, let’s say that the purchase price is negotiated and agreed upon by both parties. The deposit can typically be 3 – 5% of the price, which results in a $300,000 to $500,000 deposit. If a buyer is willing to risk that amount of money by permitting the deposit to become non-refundable, the seller will have more comfort that the transaction will close. If for whatever reason the buyer cannot complete the transaction, the seller retains the non-refundable deposit as compensation for the failed deal. During the feasibility period when the deposit is refundable, the amount is possibly not as important to the seller.
In many cases, the transaction will close within 15 to 30 days after the feasibility period ends. But on some land deals, the closing may not occur until anywhere from 6 to 36 months. Thus, the amount of non-refundable deposit becomes quite important in such an extended escrow period. The seller is taking the property off the market and the non-refundable deposit is the compensation should the buyer not perform.
Deposits are usually sent to the escrow company but only after the binding purchase contract is signed by both parties. The Letter of Intent contains the basics of the deposit, but the purchase contract has all the details and circumstances relating to how the deposit is handled during the feasibility and escrow period. I have seen some instances where a buyer might offer to send $50,000 at the opening of escrow and then send the $450,000 balance prior to the end of the feasibility period, with the full $500,000 becoming non-refundable if the buyer moves forward. To the seller, the amount that is non-refundable at the end is the most important.
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