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Foreclosures 101: Earnest money

Being creative with earnest money in real estate transactions is one of the most commonly overlooked negotiation points in a contract. Especially for foreclosures, with their battle-weary bank-owners trying to cover their butts. They want assurances. This earnest money acts as a guarantee that if you violate the provisions of the contract and walk away, the seller has something to show for their time. The lower the dollar amount, the less meaningful the gesture.

With most corporate-owned properties, if you make an offer, they require a minimum of $1,000 in earnest money to be applied toward each property. Sometimes that minimum is even as high as 3% of the contract price. If you’re unwilling or unable to put down this much money, these sellers will assume you are either not able to follow through on the contract or untrustworthy. As a rule, banks WILL NOT make exceptions to this rule.

So there’s a minimum dollar amount that has to be put down, but does that mean you shouldn’t offer more? That depends. On properties that have been sitting on the market for a long time, the minimum is usually enough. The sellers can’t be picky and choosy in this situations. However, if you are chasing a hot new property or trying to low-ball you should at least consider it. If your contract is similar to the rest on every other point, this could be the thing to push you over the edge and get your deal accepted.

So how much over the minimum should you offer? It doesn’t have to be a lot, but the more you put down the better your chances. Even a bump to $2,000 can be enough in an even playing field. When deciding how much to put down, you need to always remember that if you have contingencies in the contract you will get that money back if you void the contract through one of them. Inspection contingencies, financing contingencies… that money is never lost unless you violate the contract. That being the case, if you really want a property and have your finances solidly in order, why not offer more earnest money. You’ll be putting the money down as cash to buy or as a downpayment on the loan in a few weeks anyway.

Other than dollar amounts, you can also adjust the refundability of the earnest money as negotiation leverage. One of the most affective bargaining chips in an offer is to make the earnest money nonrefundable. You can make the it nonrefundable from the start, after the end of any inspection contingency or even as late as after any financing contingency ends. The early the better, but it never hurts to add the clause to a contract. If you are a cash buyer who doesn’t plan on doing any more inspections there is really no reason not to do this.

If you are worried that the seller could take your money and run, don’t. They have to live up to their side of the contract too, so unless you disappear before closing, the building or the money will be yours. You could never lose both on account of something the seller does or fails to do (unless your wrote the contract that way, which would be a bad idea).

In summary, when offering on a property the higher the earnest money amount and the sooner it is guaranteed for the seller, the better. In cases where you go in at full price and non-refundable immediately or within a few days, your a near lock on getting your contract accepted. If you go for the minimum with no note of earnest money possession, you’ll be at the mercy of other bidders. Don’t forget about this powerful tool in your arsenal.

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2 Responses to Foreclosures 101: Earnest money

  1. Isabelle June 10, 2010 at 10:37 pm #

    Dear Matt,

    Thank you for sharing your RE wisdom. It is most appreciated.

    Since we will be working without a buyer’s agent and with the seller’s agent exclusively, your help in this arena is welcomed. I hope you don’t mind a few questions……and although we are in a different state, your answers will help my understanding.

    Background…..
    The property has not been listed on MLS and the prior owners are still in possession. The bank and the listing agent are aware of our interest. The property is well above the average and median sale price for this area….less than 3% of all monthly sales range. I am assuming that an investor would not be interested in it, but competition would likely come from someone like us that would want it for their residence. FYI…We are pre-approved.

    Questions…..
    1) For bumping the earnest $, is 1% percentage of offer price advisable…..say $4k on a $400k purchase price?

    2) Could you please suggest wording you would use in the contract for the earnest money guarantee/non-refundable and in particular…”after the end of any inspection contingency”.

    3) Would you recommend a cashiers check over a personal check for the earnest money?

    4) Since we may not know the extent of damages (until after inspection), what is the best way to negotiate the repairs?

    Again, thank you for assisting,
    Isabelle

    • Matt Kastner June 11, 2010 at 12:13 pm #

      First off, I would recommend working with a buyer’s agent. The commission is usually the same regardless of the number of agents involved. You are probably not going to save any money by not having someone represent you. I would really recommend finding someone to work with. As for your specific questions, I don’t know your market and am reluctant to give specific advice in a situation like this. These are really questions to ask your own agent, who would be able to help formulate the best tactics for you and your market. That said, with foreclosures, I can tell you that you are generally required to submit the earnest money in the form of a cashiers check. However, for the sake of an offer, a personal check is usually fine as a starting point. In terms of earnest money $ amount, 1% really isn’t a bump-up. I would say that is actually closer to a standard amount. Something like 10% would be more in line with something that would be a bump-up. But again, I would find representation to advise you on your specific situation. You really should find a buyers agent. Best of luck.

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