Without trust, no real estate transaction would take place.
Here’s a proposal: give me $10,000 as a down payment for a custom-built, newly-constructed home. Once we agree to the terms, you won’t hear from me and I can’t be reached. I will get in touch with you when I’m done. Deal?
Unless you’re an extremely trusting soul, you’re not going to take that deal.
Let’s look at the opposite side. With no deposit, I will buy all of the land and start building a home for you. You can pay me once the project is done. Sounds like a good deal for you. But if you decided not to move through with the deal, I would have to eat the cost of purchasing the land and building the home. That’s a lot of risk.
Both of these deal will fail because there is no trust and a lot of risk. No matter how good a deal sounds or the promises that are made, nobody will part with their hard-earned money — or home — unless there is a belief that the other party will deliver what is promised.
A home buyer has to believe that the seller will transfer ownership without problems. The seller needs to believe that a buyer has the money and intention to purchase the home.
The easier it is for you or your agent to demonstrate trust to the other party, the greater the chance of a successful deal.
Relationship between trust and closing a deal
One way a buyer can demonstrate trust is through their earnest money deposit. In this article, we’re going to look at what an earnest money deposit is, what happens to the money, and how you can use your deposit to gain leverage in negotiations.
What Is an Earnest Money Deposit?
An earnest money deposit is money a buyer puts forward — upon the acceptance of an offer — to prove to the seller that they are seriously willing and able to buy the home. Often times, it’s be referred to as an EMD or “good faith” deposit. The money is a symbol of intention to purchase and creates trust with the seller.
The is no law that requires a deposit. But, most realtors working for the seller will advise their clients not to accept the offer due to a lack of commitment on the buyer’s part. Now, if this is the only offer, they might accept it. In a seller’s market, like we have as of 2017, there is a small chance your offer will be accepted without a deposit.
Since there is no law that requires a deposit, there is no set amount that qualifies as a deposit. The general best practice of “how much to put down” is usually set by the market area in which you plan to buy.
As a best practice, in Lansing, we use one percent of the offer price or a minimum of $500, whichever is higher. If you make an offer for $200,000, then your earnest money deposit should be $2,000 — best practice, but not required. If you’re buying a home for $25,000, then your deposit should be $500.
Why is it called an earnest money deposit? Where are you suppose to deposit it?
Your money should be placed in a third-party account; an escrow account with a title agency or through a real estate broker. That means when you go to write a check for your deposit, it should be made out to the title company or your agent’s brokerage.
If you’re unsure who to make the check out to, ask a realtor. If you’re not working with an agent, ask the listing agent, who you’re buying the house from, which title company they are using. Write the check out to that title agency and deliver the check directly to the title company.
You have the right to pick your own title company, according to the new laws that were created after the financial meltdown in 2008. If you prefer to use your own title company (which could increase your costs for closing), here are some title companies in Lansing I recommend:
Liberty Title – Mona Walter – 517-977-9507
TransNation – Lisa Haun – 517-974-6167
Tri-County Title – 517-323-4687
Disclosure: I am an agent of Coldwell Banker Hubbell Briarwood, which has an invested relationship with Tri-County. You are free to use your own title company and I’m not being paid to refer you to Tri-County.
Your deposit should NEVER be given to the seller and you should never write a check out to an individual. This can make it difficult to get your money back, should you need to.
“You should only be comfortable allowing your deposit to be held by an escrow company when there is an escrow agreement,” adds Patrick McVeigh, legal counsel at Liberty Title. “This agreement outline your rights — with respect to your funds — and the duties of the escrow agent. If there is a dispute between you and a seller, the language in the escrow agreement will be an important factor in determining whether you forfeit your money or get some of it back.”
Escrow accounts exist to protect you and your money. You put money into an escrow account. The escrow company holds your money until the seller delivers a clear and marketable title. You sign for the title and the money is then given to the seller.
Escrow Explained in Three Steps
Request a receipt for any money that you hand over to a realtor, broker, or title company. It should be a copy of the check with a signature of the person who accepted the check, on what date, and the location the check was received.
What Happens to Your Earnest Money Deposit?
Once in escrow, there are three things that could happen to your deposit. It’s either applied to your down payment or closing costs, refunded, or lost.
Losing money is scary, especially if your earnest money deposit is $4,000 or more. Nobody wants to lose money. While it’s possible to lose your deposit, it’s easy to protect yourself. Unless you have a complete disregard for the contract you signed, there is a good chance your deposit will be refunded if you decide not to move through with a deal.
In a complete transaction, there is nothing to worry about. The deposit you made is put toward your down payment. If you deposited $2,000 and your down payment was $40,000, then you will only need to bring $38,000 to the closing table.
Your deposit isn’t lost when you complete the deal, you just pay it upfront. Instead of waiting until the closing date, you will deposit the money once an offer is agreed on and accepted. If you had the money for your down payment and you felt comfortable with the deal closing, you could use your entire down payment to sweeten the offer, and potentially get a lower sale price.
Nothing is ever certain. I recommend depositing only money above the one-percent-best-practice that you would be comfortable losing. If you’re not willing to lose anything, then keep your deposit at one percent.
If a deal falls through, you may or may not be able to get your money back. It depends on the terms of your contract.
Every contract has a set of terms that basically say, “If X condition isn’t met, then we will exit the agreement and terms of the contract without any liability.” These are called contingencies.
A common contingency we see in our contracts is an inspection contingency. In our contract, it reads:
“This offer is contingent upon satisfactory inspection(s) of the property…”
Meaning, if you’re not happy with the results of a home inspection, you can walk away without losing your deposit. What does satisfied mean? You define it. The furnace might be older than you wanted. You can walk. The roof might be in good condition but you wanted perfect; you can walk.
As long as you exit the contract through a listed contingency, your deposit is refunded. Your money will also be refunded if for any reason, the seller terminates the contract.
Before walking away, be sure to ask your agent or seek legal advice to make sure a contingency exists. Otherwise, you may lose your money.
If you decide not to go through with a deal for reasons not listed in the contract, then you’re likely to lose your deposit. For example, most contracts require a buyer to inspect the property and make inspection requests by a certain deadline. If this doesn’t happen, then you may lose your money.
For example, our contracts also state:
“If BUYER fails to obtain inspection(s) or fails to notify SELLER’S agent, in writing, within the timeframe specified that BUYER is dissatisfied with any inspection(s), and/or research and discovery of information pertinent to the property, this Agreement shall be binding without regard to said inspection(s).”
Meaning, if you do the inspection(s), but don’t tell the seller you’re dissatisfied, then you may lose your money if you back out under the contingency clause. Unless of course, you’re dealing with a kind and generous seller.
As long as you’re smart and careful, it’s rare to lose your deposit. However, there is always a certain level of risk. For that reason, offer a deposit amount that you’re comfortable with.
Leveraging Your Deposit In Negotiations
Your earnest money deposit should be seen as a tool to help you get what you want. The right deposit could sweeten a deal, it could help you win a bidding war, or even get the home for a lower price.
For example, one of my clients was paying cash for a house. We raised our earnest money deposit beyond the standard one percent to get the seller to agree to a 1.4 percent reduction in the sale price. My client was able to get the home for a lower price by putting more money in the game.
In negotiating, it’s not always possible to get something without giving. If you want the seller to reduce the price, you may need to increase your earnest money deposit. If you want the seller to extend the closing date, you may need to increase your earnest money.
For example, if you’re at $225,000 as an offer price with a $2,250 earnest money and the sellers seem unwilling to budge, you could try $220,000 with a $10,000 earnest money. This is a purely hypothetical example for illustrative purposes and is not meant as advice.
Sometimes you will need to give in the areas you don’t care about or are comfortable with so that you can get what you want in the areas you do care about. This applies to all of negotiating. If your closing date is super important, you may need to be flexible on price or contingencies.
This chart is a good illustration of what I’m saying. On the left-hand side, or y-axis, we have assertive or passive. On the bottom, or x-axis, we can see the level of cooperation. The only way to get a deal done (and feel like we won) is to be in the sweet spot of compromising.
If we’re asking for a lot without giving, we tend to sit in the upper left corner, or competing. Making a deal work in this quadrant can be difficult. You will need to become more cooperative and willing to give.
Sweet Spot on How Deals Happen
A higher earnest money deposit will show a seller that you’re extremely motivated to buy their home. This will give the seller comfort and allow you to negotiate on other terms of the contract. When you’re negotiating, don’t always think price.
How Much Will You Deposit?
Your earnest money deposit shows a seller that you’re willing and able to pay for the home you want. In a successful transaction, the money is rolled into your closing costs and down payment. It’s in your best interest to put down as much as possible — assuming you keep yourself protected because you could lose the money.
If you’re looking for help on how much to offer, get in touch with the Dolinski Group. Not ready? No problem.
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