Contract Deposits and Cancellation Fees: How Earnest Money Works
It serves as both a stamp of commitment and a 'cancellation ticket' if you change your mind.
Definition A contract deposit (earnest money) is money paid upfront to seal a deal on property or goods. A cancellation deposit (haeyakgeum) is a legally recognized fee paid to unilaterally back out of that contract. Unless agreed otherwise, the initial deposit automatically functions as the cancellation deposit.
How Does a Deposit Become a Cancellation Ticket?
You have probably paid a reservation fee when booking a popular restaurant or vacation rental. Similarly, in real estate or major transactions, the buyer pays a portion of the total price upfront (usually 10%) to seal the deal. This upfront money is called a contract deposit.
What happens if someone changes their mind after signing? Under the Civil Act, the initial deposit is legally presumed to act as a cancellation deposit (haeyakgeum) unless specified otherwise. This provides a legal exit route, allowing either party to walk away by paying an economic price.
The rule is straightforward. If the buyer or tenant wants to cancel, they must forfeit the deposit already paid. Conversely, if the seller or landlord wants to call off the deal, they must repay double the deposit amount (double refund) to terminate the contract.
When Is the Deadline to Change Your Mind?
Forfeiting a deposit or paying double does not mean you can back out at any time. The law only allows cancellation via deposit forfeiture before the other party begins serious preparations to fulfill the contract.
This critical legal milestone is called the commencement of performance. In real estate transactions, this point is usually reached the moment an interim payment (jungdogeum) is made into the bank account. Once even a partial interim payment changes hands, the deal becomes legally locked in.
After an interim payment is made, unilateral cancellation without mutual consent is impossible, regardless of how much extra money one offers. From that point on, both parties must pay the remaining balance and close the deal. Backing out then constitutes a breach of contract, carrying severe legal liability for damages.
Key Distinction: How Does It Differ from a Penalty?
People often confuse a cancellation deposit with a contractual penalty (wiyakgeum). A cancellation deposit is money paid to purchase the 'right to lawfully cancel' a deal. A penalty, on the other hand, is a fine paid when one party 'breaks an obligation.' A deposit only serves as liquidated damages or a penalty if there is a specific special clause in the contract stating that "the deposit shall be treated as a penalty upon breach."
Another widespread myth is that you can get a full refund if you cancel within 24 hours of signing. Legally, a contract takes effect immediately upon signing or verbal agreement, meaning the cancellation deposit rule applies even after just one minute.
When entering high-stakes deals like buying a home or car, review every term carefully before transferring any funds. Once sent, that money becomes your most powerful legal promise to see the deal through.
๐ค Common misconceptions
You can receive a full deposit refund if you cancel within 24 hours of signing.
No 24-hour statutory cooling-off rule exists for general contracts. The agreement takes effect immediately upon mutual consent and payment, so backing out even minutes later requires forfeiting the deposit or paying double.
๐งบ Where you meet it
A contract deposit seals a deal and serves as a cancellation fee before interim payments, allowing buyers to cancel by forfeiting it and sellers by paying double.