Negotiating Earnest Money Deposits
An earnest money deposit is always a bit of a challenge for real estate investors. Real estate agents and some sellers tend to ask for really large earnest money deposits, but paying large earnest money deposits can be a huge challenge for real estate investors, especially since they make multiple offers in order to make deals happen. If you were to make 10 offers this week on properties and each one required $2,000 in earnest money, what would that do to your ability to be an active investor? Let’s examine the truth about earnest money in terms of the law and provide a practical approach on how to make your offers include earnest money that is reasonable and practical.
As far as we are aware, the laws across the United States require that there be “consideration” in making an offer to purchase real estate. Consideration refers to the offering of something of value from the buyer to the seller for them to consider the purchase offer. In years past that may have been a chicken or a new harness. Today it is most commonly money. The law does not usually specify how much money qualifies as consideration, nor when that consideration needs to be paid.
There are ample cases in most states indicating that $1 represents “good and valuable consideration” for the purchase of real estate. So to offer a relatively low consideration is a right that exists in all states, and the money does not have to be paid upon acceptance of offer to open escrow on the property. Escrow is a collection of money and/or documents held by a third party in connection with a real estate closing. Escrow can be opened with only a purchase agreement going into the escrow at the beginning.
I have found that in making offers, the person who makes the offer has an advantage, so we ought to use that advantage to make an earnest money proposal that works for us. Here is an example of what we would suggest for an earnest money proposal: “The earnest money deposit shall be $300 due and payable at closing.” It has been amazing to me how frequently this proposal has been accepted just because it is in writing and included with a bona fide offer to purchase.
Not all sellers will accept an earnest money proposal like the one above. For example, on foreclosed properties, the lender who owns the property, or the government agency who owns the property, often has set regulations that they will not bend. Institutional sellers have a right to set these regulations if they choose. Since most private sellers are a little more flexible, the above proposal is more likely to be acceptable to them. After all, earnest money deposits go into a safe or a bank account and cannot be accessed or spent until after closing. There are no shopping sprees at Costco available to the seller.
If the seller resists your earnest money proposal, they will probably counter with a request for more money due sooner than closing. Let’s say they ask for $2,000 and want it to be due within two days after they sign the agreement. You can respond with the following:
- Well, I’m reasonable and negotiable, and it sounds like you are opening some negotiation.
- You have requested two modifications to my proposal—A) The amount of the earnest money deposit; and B) When the earnest money deposit will be made.
- In the spirit of negotiation, I’m willing to allow you to select either one of the two modifications, and I will take the other one. So if you want $2,000, I get to select when it will be paid, and I choose payable at closing. Or if you want the money within two days, I get to select the amount, and I choose $300.
- If you are unwilling to negotiate, then I will need to terminate my offer. Keep in mind that there are a lot of opportunities for me. I can make 20 offers today if I want to, but you need to sell just this one specific property, and I am a bona fide buyer making a bona fide offer.
Obviously, I’m not able to have this discussion in every situation, but I have made certain that my real estate agents understand and support my approach, and we use this “two choices” approach frequently, and we’ve shared it with many other investors who have also implemented it successfully.
You may have to make a few extra offers along the way, and you always have the right to agree to pay a larger amount if that works for you. We want to assist in every way we can to create greater success for you as a real estate investor. And remember that real estate deals are made, not found.