What are Liquidated Damages in Real Estate?

What are liquidated damages? Most real estate transactions follow the same structured procedure to meet the needs of the home seller and the homebuyer. If everything goes well, both parties walk away happy.

However, there are instances where something erupts in the transaction causing disparity between the parties and damage could be dealt. The good thing is, real estate agents and the real estate transaction process has procedures in place to compensate for damages dealt to a party.

In this article, we explore the power of liquidated damages and the role they play in the real estate transaction.

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What are Liquidated Damages?

Liquidated damages is a legal clause that protects the real estate agent’s client from additional exorbitant fees. In the event of a contract breach, the injured party is compensated with the funds that are set aside in an escrow account that are equal to the amount of damage caused by the offending party.

So, now that we know what liquidated damages are, let’s explore when and how liquidated damages come into play during a real estate transaction.

How Liquidated Damages Work

When a real estate offer is made and accepted by both parties, the seller will require the buyer to make a deposit, typically 3% of the purchase price, into an escrow account as financial security. The purpose of this deposit is to alleviate any damages a seller incurs if the buyer backs out of the deal.

At first glance, the damages caused with backing out of a deal might be hard to discover. But, let’s dig deeper to see the full picture and how these expenses add up for the home seller.

Why the Liquidated Damages Clause Matters

So, why is the liquidated damages clause important? Let’s lay out a scenario. A buyer and seller have entered a contract on the sale of a one million dollar home. As part of the contract, the buyer deposits $30,000 dollars into an escrow account.

While waiting for the deal to close, the buyer requests some repairs on the property. The seller deems the requests reasonable and performs the repairs. In the meantime, the seller is preparing to vacate the property (scheduling moving services, making large purchases, etc). At some point in the process, the buyer calls off the deal.

What happens now?

The seller has already spent money making expensive repairs and preparing to close the sale. At this point, all of the contingencies have cleared. The seller has jumped through all the hoops. Does the seller just lose out on all the money promised in the sale?

This is where the liquidated damages clause comes in. The buyer can recoup their losses with the money in the escrow account. However, it’s not a simple process.

Liquidated Damages and Negotiation

Neither party is automatically entitled to the money in the escrow account. The buyer and seller must negotiate and agree on what to do with the money. Sometimes, the two parties can’t come to an agreement. What happens at this point? This leads to arbitration – which is an entirely different ball game.

Final Thoughts on Liquidated Damages

It’s important for agents to make sure the liquidated damages clause is included in the contract for every sale because it acts as a final protection for the seller in a real estate transaction. In the event that the buyer backs out of the contract, the seller can collect escrow funds as reimbursement for paid expenses during the closing process.

Have you or a client ever needed to enact the liquidated damages clause? Tell us about it below?