Earnest money is defined as follows: “A sum of money paid by a buyer at the time of entering a contract to indicate the intention and ability of the buyer to carry out the contract.” Normally such earnest money is applied towards the purchase price. Often the contract provides for forfeiture of this sum if the buyer defaults. If the deal falls through, the buyer may not be able to reclaim the deposit. Typically, if the seller defaults on the agreement, the earnest money will be returned to the buyer. When the buyer is responsible for defaulting on the offer, the seller will usually be awarded the money.
Why is earnest money important in a market of low inventory and multiple offers? Well it can give the listing agent and the seller some insight into a number of things: a) how serious is the buyer, b) how confident is the buyer, and c) how “able” is the buyer? Let me explain. First, people always ask what is considered a “norm” for the amount of earnest money. While this can vary greatly, as a rule of thumb in Las Vegas I would say between 1%-2% of the sales price; depending on the nature of the home (REO vs. high end custom home) and the situation. Buyers hate to put their earnest money deposits “at risk,” and this is certainly understandable. However, there is a difference between putting it at risk and the old expression: “putting your money where your mouth is.”
Let me use the example of a “hot property” that just came on the market and has 6 offers in three days. Let’s say it’s a $200,000 property. In scanning the offers, I see earnest deposits ranging from $1,000 to $5,000. So right off the bat, we can see who appears confident and who wants to show me they are “able.” Oh… 4 of the checks show the buyers name on the check, one is from a buyers “Mom.” Can you spell confidence? All the offers involve financing. So these deposits are only as good as the buyer’s ability to obtain a loan. If the financing contingency falls through, the deposit is refundable to the buyer, unless the contract called for other provisions. All of them tell me their buyers are “well qualified” and have no problems! Yet one steps up and tells me he is willing to make his earnest deposit non-refundable with three provisions: 1) the home has to appraise for what he agreed to pay and 2) the buyer has to approve of the home inspection within a specific time period and 3) the seller cannot breach the agreement (seller cannot default or fail to adhere to the agreement). Now that’s somebody that means what they say! By the way, this scenario is essentially what all bank owned property (REO) counter offers require in a nutshell.
Another example: short sales. Due to the length of time involved with short sale approval, many buyers don’t want to “tie up” a larger sum of money while waiting for the approval. Therefore they will suggest a $1,000 or $2,000 deposit. I have seen this to be true even on a $300,000 to $400,000 home. How about taking a two stage approach? Buyer agrees to place a $3,000 earnest deposit into escrow upon acceptance with the seller and within 48 hours of receiving written short sale approval, he agrees to increase the deposit to a total of $10,000! This can be very powerful for one big reason: the Seller and listing agent’s biggest fear is a buyer “walking away” once an approval is finally obtained. Here’s some real insurance that will not happen.
I am not advocating putting your Buyer clients at risk and there are ways to protect your clients in purchase agreements. However, “earnest” is all about showing deep sincerity. So when you want to distinguish your buyers from the pack…do just that! Show some real sincerity and let them know you really mean what you say!