Investigating Earnest Money: All That You Need To Know & More

Whenever you formally make an offer to buy real estate, it is traditionally routine to pay an EMD (earnest money deposit). This is a sum of money that ultimately shows the seller your credibility as a buyer and that you are going to adhere to the terms of the contract and purchase the property.

As a real estate investor it is important to understand exactly how the earnest money is handled between you and the seller, especially if you are planning on flipping the property.

The purpose of earnest money is to show the seller your good faith to buy the property.

Earnest money is to be held in escrow and later applied to the purchase on the day of closing. This means that if you sign a contract with a seller and then all of the contingencies are removed and you don’t close on the contract, you actually forfeit your earnest money and the seller gets to keep it.

Understanding earnest money can be a little tricky when wholesaling houses because you have to think about the earnest money from you to the seller, and then there’s also earnest money between you and your cash buyer.

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When it comes to earnest money between you and the seller, there are a few guiding points that you are going to want to remember and stay consistent in following.

Earnest Money Is What You Make Of It

Talking point number one is the fact that there is no required amount of earnest money.

It can be just a dollar, or it could be scaled to $10,000. All in all, it’s up to whatever you and the seller agree to. But you must remember that there can be serious consequences for being inactive on the contract, which could cause you to forfeit your earnest money to the seller.

You want your earnest money deposit to be as low as possible, as this reduces your risk in the event that you can’t perform on the contract. This obviously shows us that sellers want the earnest money to be as high as possible to lower the risk of you walking from the deal.

When in business with private sellers, you can usually offer a very low earnest money deposit between $10 and $100. However, some sellers require more advanced deposits. These EMDs tend to fluctuate between 100 dollars to 1,000 dollars.

When it comes to on-market properties where there are agents involved, usually your earnest money is between $500 and $1,000 because the agent’s end goal is to get a higher earnest money deposit.

Keep in mind that when dealing with a more sophisticated seller like bank-owned properties called REOs, the larger your earnest money deposit is, the stronger your offer becomes.

Only Pay The Earnest Money Deposit When The Contract Is Set In Stone

It is vital to remember that you should never pay the earnest money deposit until after you have an executed contract. Many investors make this mistake and provide the earnest money deposit with their offer up front.

This is common with real estate agents as they often ask you to write a check for the earnest money deposit, to be presented with your offer. You should do your absolute best to never give in to this.

Instead of caving and selling yourself short, go ahead and provide a copy of an earnest money check so the seller sees a copy of your earnest money.

Your offer feels more legit when this has been done, and you don’t actually pay the earnest money until after you have an executed contract, which gives you even more of an upper hand in this situation.

Never Pay An EMD To A Seller

The third thing to keep in mind is that you never want to pay the earnest money deposit directly to the seller.

As stated earlier, earnest money is to be held in a protected escrow account and eventually be applied towards the purchase at the closing. In regards to on-market properties, it is usually held in the real estate broker’s escrow account. If it is an off market property, you will want the title escrow or attorney who will be handling the closing transaction to hold it in their escrow account. In the event that the seller doesn’t meet his or her terms of the contract or you decide to exercise a contingency and terminate the contract early, you can still get your earnest money back.

If you gave the earnest money to the seller, good luck trying to get it back.

Prioritize The Protection Of Your Earnest Money Deposit

If you really want to make sure that you aren’t wasting your own precious time investing in real estate, you are going to want to protect your earnest money to the best of your ability. Your earnest money doesn’t become nonrefundable, or ‘hard’ until all of the contingencies are removed from your contract.

A contingency is a clause in your contract that allows you to back out of the contract without any repercussions. The most common contingency is an inspection contingency.

You can include a specified time for you to inspect the property within your contract. This is typically anywhere from one to ten days. You and the seller must come up with an agreement and decide whether an inspection will be done or not. Whatever you and the seller agree to do is besides the point, considering this will give you some time to back out of your contract and get your earnest money back if that becomes your best option.

After that time frame, if you have no other contingencies your earnest money would go ‘hard’ or non-refundable. If you don’t act quickly within the contract, you will lose it. Instead of terminating your contract, keep in mind if for some reason you don’t perform on the contract, the only real consequence is that you lose your earnest money. The seller could technically sue you for non-performance of the contract, but if that were the case, the seller could not sell it to anyone else while he’s spending thousands of dollars in legal fees trying to force you to buy his property. This scenario is extremely unlikely. The point is, you should always make it a high priority to monitor your earnest money and understand when it goes hard and starts to become risky.

Now let’s analyze how earnest money works between you and your cash buyer. You are already conditioning yourself to hold onto the buyer’s perspective, so you need to flip roles now and look at earnest money from the seller’s perspective, since you’re now flipping your contract to a cash buyer.

Always Get An EMD From A Cash Buyer

Always get earnest money from your cash buyer. You should try to never make the mistake of not getting an earnest money from your cash buyer, this is their skin in the deal.

If a cash buyer doesn’t pay in earnest money, it is easy for them to back out of the deal.

Substantialize Your EMD

Not only should you get earnest money from your cash buyer, but it should be big enough to really commit them to the deal.

My minimum earnest money deposit that I recommend is twenty five hundred dollars. On occasion, I’ll go as high as five thousand dollars.

You will want to make sure that you don’t lock up your deal with a flaky cash buyer who’s not 100% serious about buying your contract and closing on time.

Make Your EMD Non-Refundable

You are also going to want to make the earnest money deposit non-refundable. This means no contingencies! Unlike your contract with the seller, you do NOT want your cash buyer to have a way to back out of the contract later.

If the cash buyer that you are dealing with says he needs time for due diligence, tell him to do his due diligence first and then execute the assignment contract. Meanwhile, you should find a cash buyer who’s already done their due diligence and is ready to sign a contract with no contingencies and put down a non-refundable earnest money deposit.

Have The EMD Made Out To You Or Escrow

It is helpful to have earnest money made out to you.

However, if the cash buyer doesn’t want to make it out to you for the same reason we disclosed earlier, just have it made out to the title escrow or attorney who will be doing the closing transaction.

How To Avoid Paying Earnest Money Deposits

In this section of the article I will walk you through a bonus strategy where you have the ability to not pay an earnest money deposit.

First off, when you execute your contract with the seller, put in your contract: ‘earnest money deposit of $2,500 to be paid at the end of due diligence’.

Then, put a ten day inspection due diligence in your contract. This means that you will owe the $2,500 earnest money at the end of the ten days. The seller will have to agree to this, but since you made it twenty five hundred dollars and not just one hundred dollars, they are more likely to agree to this.

After all of that, during the ten day due diligence period you’ll want to find a cash buyer and get him to agree to pay a $2,500 non-refundable earnest money, which you will use to pay your $2,500 earnest money that is owed to the seller.

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