Earnest Money: When More is Less

Law of Diminishing Returns

If you don't like technical, legalistic real estate posts -- stop reading here.

Earnest money (called "unrest money" by at least one recent Buyer) plays an overlooked but critical role in every real estate deal.

Typically 2% to 5% of the purchase price, given by the Buyer to the Seller as part of the offer, earnest money actually accomplishes two things: 1) it establishes the Buyer's financial bona fides and commitment to the deal (think of it as the "down payment on the down payment"); 2) it serves as what lawyers call "liquidated damages" if the deal goes south.

In layman's terms, it is an upfront, agreed-upon estimate of what the Seller's damages will be if the Buyer fails to close (typically, for lost market time).

In other words, if the Buyer walks, the Seller keeps the earnest money, and both parties move on.

Theory vs. Practice

Except that in practice, earnest money can become a bitter bone of contention.

That's especially the case if the Buyer feels the Seller shares responsibility for the deal not closing -- and the earnest money is unduly large.

Then, instead of simply forfeiting the amount and walking away, the Buyer may decide that it's worth fighting over.

They can threaten litigation; refuse to formally cancel the deal, which prevents the Owner from selling to anyone else (and can then require that the owner go through the hassle of obtaining a statutory cancellation to get free of the Buyer); or cause various other mischief and headaches.

Ironically, in the rare instance when one of the foregoing scenarios occur, Sellers belatedly realize that the hefty earnest money check that was supposed to protect them instead can mire them further in a mess.

Pre-Approval Letters & Written Statements

What Are They Really Worth?

Put it this way: the picture of toilet paper should give you a hint.

First, some background.

In Minnesota, the first things that typically lead off any offer to purchase residential real estate are the Buyer's earnest money check, and a pre-approval letter from a lender (unless the Buyer is paying cash).

The standard pre-approval letter recites that the lender has initially screened the Buyer's finances and credit scores, and, based on that quick review, says that the Buyer can afford the home.

In practice, a pre-approval letter almost always means . . . nothing.

Most lenders will issue them in less than 10 minutes on the phone with a prospective borrower, after collecting the most basic information.

Meanwhile, their express language explicitly states that nothing in the pre-approval letter obligates the lender issuing it to actually fund the loan.

The Written Statement

Which is where the Written Statement supposedly comes in (think of it as "the Final Approval" Letter).

Once the Buyer and Seller reach agreement on terms, the Purchase Agreement typically includes a Financing Addendum that calls for the Buyer to deliver a Written Statement within 2-3 weeks.

The standard Written Statement recites that an appraisal satisfactory to the lender has been completed; presumes that the lender has finished vetting the Buyer's W-2's, recent tax returns, and any other Buyer financial "bona fides"; and lists any outstanding conditions remaining -- usually pro forma ones, like the Buyer not blowing up their credit or losing their job.

Once the Buyer delivers the Written Statement to the Seller, the Buyer's loan is supposed to be finally underwritten -- and the Buyer's earnest money becomes non-refundable.

O-for-2

Except that in practice, that's not how it works today.

Now, skittish lenders can and do reserve the right to revisit the loan at any time up until closing.

They may request additional Comp's to substantiate the value of the collateral (the home being purchased); ask the Buyer for (still) more financial documentation; or tweak (tighten) their underwriting standards.

Or all of the above.

The result?

What was supposed to be a finally underwritten loan suddenly . . . isn't.

All of the foregoing means two things:

One. Buyers and Sellers today, especially when upper bracket properties are involved, should consider drafting custom language to address the Buyer's financial qualifications, and defining when their earnest money becomes non-refundable; and

Two. Sellers shouldn't load up the moving van until they know, for sure, that the Buyer's financing is good.

"The Close," "The Trial Close," & "The Reverse Trial Close"

Sales Repertoire

Consciously or unconsciously, every successful sales(wo)man develops some variation of the following techniques:

The Close. "Sign here."

The Trial Close. "If they agree to beef up the earnest money, is it a deal?"

The Reverse Trial Close. "With all those objections, this home sure doesn't seem like a very good fit for you."

If the objections are real, simply acknowledging that -- directly and honestly -- saves everyone time.

If the objections instead are disingenuous or posturing, nothing shifts the leverage faster than agreeing that the would-be Buyer's (long) list of flaws truly are deal breakers.

P.S.: my clients know one of my favorite anecdotes about Buyer feedback.

Way back when, I got an email from a Buyer's agent detailing -- in great length -- all the flaws in my client's home: the kitchen was hopelessly dated, the floor plan felt awkward, the bedrooms were small -- and on and on.

The last line?

"My clients are very interested. Please keep me in the loop."

When Is It REALLY a Done Deal?

Milestones in a Deal

If you're an office manager, stop reading here.

If you're not . . . continue.

So, when is a real estate deal really a done deal?

It's not when the last signature lands on the last blank line in the Purchase Agreement.

It's not the technical, legal definition, i.e., when the now-executed Purchase Agreement is constructively delivered to the other party (getting it to their agent qualifies).

And it's not even when the legal consideration -- the earnest money check -- is received or deposited.

Give up?

It's when the Realtor turns in the sale (at least so far as Buyers' agents are concerned).

Real Estate's "Fat Lady?"

While MLS rules strictly prescribe such things as how long brokers have to deposit earnest money checks, the reality is that agents -- especially Buyers' agents -- have been known to procrastinate turning in the paperwork accompanying a sale.

No doubt that's because Realtors as a group tend to be allergic to paperwork.

And it can also be because of various loose ends, or because needed information -- like who's doing the closing -- isn't known yet.

But there's a larger, practical element.

Realtors find the time to collect that info once the deal has slowed a down a bit. Not coincidentally, that's also usually the point when the deal has firmed up.

But it's also the case that Realtors don't make the time to pull all the sale paperwork together until they're reasonably confident that it's a done deal.

Turning in the paperwork is tantamount to saying, "Done!"

P.S.: Unfortunately, while turning in paperwork promptly can avert a fine, it won't get you paid any faster; that only happens when the deal closes, typically 4-6 weeks later.

Buyer Freudian Slips

So THAT'S What That Check is Called

A colleague just showed me an earnest money check in a deal they're handling.

Except that's not what the Buyer wrote in the check's "memo field."

Instead of "earnest money," they wrote "unrest money."

Not too far off . . .