Learning the trade, Earnest Money Deposit?

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Learning the trade, Earnest Money Deposit?

Jerome Harrod II
Professional · Baltimore, MD · Member since 2010 · 79 posts · 47 votes

How does earnest money deposits works? As I was reading, I saw that when dealing with new buyers many wholesalers had made the buyers pay an earnest money deposit. Is this a recommended practice? Why? How much do I ask for when requiring a earnest money deposit?

The reason is that I'm looking to expand with dealing with notes as a broker into wholesaling real estate as my entry to being a real estate investor. I took Financexaminer's advice to read through key points in Wests Business Law Text book, and I feel as though have a better grasp on Laws and ethics.

Now to start, I have been researching the art of wholesale here in BiggerPockets, and boy was there alot to read and learn. I even expanded to outside resources such as the library and other internet resources to solidify information and get more perspective of wholesaling.

I feel I got a grasp on how the wholesaling process works in terms of finding buyers and the homes when dealing directly with the home owner. However, I don't feel comfortable interacting with realtors until I'm more experienced. I think I need to somehow make a script to study so my answers to those hard questions won't begin with "uhh" and end with "umm".

What I don't know are the little gaps in information, such as How do I pre-screen a buyer to see if he's good? or How do I introduce myself to a potential prospects?. Another question was how do I start wholesaling "virtually"?

I know I have a bad tendency of over explaining myself and I asking alot of questions, so to start somewhere basic, Could someone explain Earnest Money Deposits?
I mean, If you have the answers to my other questions then by all means I ask for the answers plus tips. I'm looking to absorb and retain any and all quality information, to learn everything I can to be successful.

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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
16y
Originally posted by Bryan Hancock:
I put $10 earnest money down on all of the distressed properties I buy. To my surprise I recently got a trumped up demand letter for a property I bought subject-to where the opposing attorney claimed $10 was not sufficient consideration.


Reading through my wife's real estate textbooks, it is made very clear that for a Purchase & Sale Agreement, the consideration is NOT the earnest money deposit.

Here is the exact text from the Georgia MLS Training Institute, which provides prelicense training for Georgia real estate agents:

"In a real estate contract, consideration is NOT the earnest money, but the exchange of the purchase price (or something else of value) for real property."

(Note the capitalization of the work "not" above was theirs, not mine)

Reading further through the text, it's clear that earnest money -- while a good idea -- is not required for either a valid or an enforceable real estate contract.
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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    When you write a contract to purchase a property, "earnest money" is typically provided by the seller to the buyer to prove you're "earnest" about making the deal. With a property that's listed on the MLS, the sellers will typically specify the minimum earnest money they will accept.

    If there are contingencies in the contract (typically, financing and inspection), and the buyer backs out using one of these contingencies, they get the EM back. If the contingencies expire, and the buyer doesn't close, the seller keeps the EM.

    When you contract directly with a seller, you can try to get away with a tiny earnest money like $10 or some such. If a property is on the MLS, the amount will be higher.

    In some states, some "consideration" is required to make a contract binding. That's the earnest money.

    1Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y
    Originally posted by Jon Holdman:
    In some states, some "consideration" is required to make a contract binding. That's the earnest money.


    Is this not the case in all states Jon? I thought consideration was a fundamental element of all contracts. I am assuming you mean that money is required in some states for it to be considered adequate consideration. Is this inaccurate?

    I don't really do deals outside of Texas so I am not really familiar with other state's laws.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    I thought too, Bryan, until Bill Bronchick brought the subject up at a CAREI meeting. According to Bill, nothing is required here in CO. Since he's a lawyer and does lots of deals here, I'm assuming he's correct.

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y

    Maybe Bill can pick this thread up and let us know what is required. I am pretty sure consideration is required to have a legally binding contract. Surely that hasn't changed. My suspicion is that Colorado or other states don't require earnest money as consideration for a legally binding contract. Perhaps a promissory note or something else of value from the buyer constitute valid consideration so that the transaction isn't considered a gift.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    I know I'm not the Bill you were expecting, but, IMO, having a binding contract may not require monetary consideration, but a promise to do something can be sufficient. The old line...for and in consideration of ten dollars, paid in hand as well as other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree...

    And, I have use earnest money notes many times, it may have been most of the time, but not so much now since people are really looking for something to keep in hand in the event a buyer (they don't know) fails to perform.

    Jerome, thanks for mentioning that, read the book it will help understand many aspects of basic business relationships.

    If you wait until you feel confident about speaking without any uhhs and umms, you won't be in real estate! Get with a newbie Realtor that you feel comfortable with and explore the business, what you learn off of each other can be helpful.

    Get with another Realtor/player type and tell them you're learning the business and what your interests are. Find a Realtor you are comfortable with firts, even if they don't have a listing to show you. The realationship comes first, not the property. When you know someone you can communicate with and work with, then look for the properties! Good luck, Bill (G.)

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  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y

    Consideration is required in any contract, but consideration doesn't have to be money.

    Every contract requires an offer, consideration and acceptance. How these different elements get defined varies greatly both at the state and federal level.

    1Reply
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    16y

    "Consideration" is required for a contract to be valid. And from the dozen states or so that I have researched in the past, "consideration" can be just a "promise" to buy. An actual earnest money deposit is NOT a requirement of valid consideration or a valid contract.

    I believe, but have absolutely no evidence, that this is a national courts interpretation/decision or a generally accepted interpretation of contract law because of how similarly I've seen it phrased in different states.

    Not to say that there aren't states that interpret it differently, but the dozen or so I have researched are all the same.

    In Texas at the least, I have had this discussion with several very well qualified attorneys, and they all agree that earnest money is NOT required for a valid and enforceable contract in Texas. They won't ever give me any definitiveness on any other states, though.

    I personally only put earnest money on deals that are listed with realtors, and that's because any realtor worth their weight in dirt is going to require you to.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    16y
    Originally posted by Jon Holdman:
    When you write a contract to purchase a property, "earnest money" is typically provided by the seller to the buyer to prove you're "earnest" about making the deal. ...


    I believe that Jon has this reversed, and that the above excerpt SHOULD read:

    Changes shown in uppercase are the corrections I suggest.

    1Reply
  • Mark UpdegraffBusiness Member
    Real Estate Broker · Rochester, NY · Member since 2010 · 1k+ posts · 701 votes
    16y
    Originally posted by Steve Babiak:
    Originally posted by Jon Holdman:
    When you write a contract to purchase a property, "earnest money" is typically provided by the seller to the buyer to prove you're "earnest" about making the deal. ...


    I believe that Jon has this reversed, and that the above excerpt SHOULD read:




    Changes shown in uppercase are the corrections I suggest.

    Come to my neighborhood, the houses are so deferred that Jon's case is correct ;-)
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  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    16y
    Originally posted by Mark Claire:

    Come to my neighborhood, the houses are so deferred that Jon's case is correct ;-)


    Mark, you're so secretive we don't know where that neighborhood would be :wink:
    0Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y
    Originally posted by Ryan Webber:
    I personally only put earnest money on deals that are listed with realtors, and that's because any realtor worth their weight in dirt is going to require you to.


    I put $10 earnest money down on all of the distressed properties I buy. To my surprise I recently got a trumped up demand letter for a property I bought subject-to where the opposing attorney claimed $10 was not sufficient consideration. This was obviously the blanket "scare letter," but he was using this argument to claim that the contract wasn't valid.

    We settled so I have no idea what would have happened if the thing went to court. They really had no leg to stand on and were just trying to be an annoyance to get a settlement...which worked. Our legal system in this country is ridiculous.

    I have also heard that a promissory note or other "good and valuable consideration" are sufficient. It seems like $10 is well worth the cost to establish concrete consideration though. What else are you guys using for consideration? Is it worth $10 in the case that the contract is later challenged?

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    Thanks for the correction, Steve. Of course you're correct. Doh!

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    16y

    Jon,

    The amazing thing is how many experienced folks posted back on this thread and missed that! Being human, we all make mistakes along the way.

    0Reply
  • Kim Anderson
    Real Estate Investor · Tampa, FL · Member since 2009 · 64 posts · 62 votes
    16y

    I was thinking that the OP was referring to the earnest money deposit that wholesalers typically require from their buyers, although I may have misunderstood his question.

    But for what it’s worth, Jerome, you will always want to get a deposit from your buyer for the opportunity to take over your position in your contract with the seller. So at the time when you and your buyer are signing the “assignment contractâ€, have the buyer pay you a non-refundable deposit. If for some reason the buyer ends up dropping the ball and does not actually close on the property, they do not get their deposit back. Wholesalers typically do this so that the buyer has a strong incentive to actually close.

    How much for the non-refundable deposit is up to you. I have seen as low as $500 and it goes upwards from there into the thousands. But, $1K or $2K seems to be the norm in my neck of the woods.

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  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    16y
    Originally posted by Bryan Hancock:
    I put $10 earnest money down on all of the distressed properties I buy. To my surprise I recently got a trumped up demand letter for a property I bought subject-to where the opposing attorney claimed $10 was not sufficient consideration.

    . . . It seems like $10 is well worth the cost to establish concrete consideration though. What else are you guys using for consideration? Is it worth $10 in the case that the contract is later challenged?

    Obviously your $10 deposit wasn't "sufficient" enough to be above reproach as concrete consideration.

    If the law doesn't require me to put $10 as a deposit for a valid contract, then I won't. The only times I ever have given earnest money when dealing directly with a seller is when they are adamant about it, which has been I think twice out of a couple hundred.

    You either need it for a valid contract or you don't, and the fact is you don't. So why do it for that reason? Now there may be other considerations for why you give earnest money, but to do it so you have a valid, concrete, unchallengeable contract is a waste of your money.

    0Reply
  • Ryan Webber
    Wholesaler · Amarillo, TX · Member since 2008 · 1k+ posts · 659 votes
    16y

    Jerome, as for taking earnest money when you are selling and to fill in some more of the gaps here, read through this old post:

    http://www.biggerpockets.com/forums/93/topics/4274-assigning-contracts-wholesaling-questions

    0Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y
    Originally posted by Ryan Webber:

    Obviously your $10 deposit wasn't "sufficient" enough to be above reproach as concrete consideration.

    If the law doesn't require me to put $10 as a deposit for a valid contract, then I won't. The only times I ever have given earnest money when dealing directly with a seller is when they are adamant about it, which has been I think twice out of a couple hundred.

    You either need it for a valid contract or you don't, and the fact is you don't. So why do it for that reason? Now there may be other considerations for why you give earnest money, but to do it so you have a valid, concrete, unchallengeable contract is a waste of your money.


    I think we would have won if it went to court and the contract was valid. It wasn't worth fighting though and I just sold the property back to the original seller for cash after the lease I had with a tenant ended.

    I understand that it may not be required, but it seems to strengthen the case for consideration a bit. To what extent I am not sure.

    What do you normally claim as sufficient consideration in your transactions if you don't use cash?

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  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    16y
    Originally posted by Bryan Hancock:
    I put $10 earnest money down on all of the distressed properties I buy. To my surprise I recently got a trumped up demand letter for a property I bought subject-to where the opposing attorney claimed $10 was not sufficient consideration.


    Reading through my wife's real estate textbooks, it is made very clear that for a Purchase & Sale Agreement, the consideration is NOT the earnest money deposit.

    Here is the exact text from the Georgia MLS Training Institute, which provides prelicense training for Georgia real estate agents:

    "In a real estate contract, consideration is NOT the earnest money, but the exchange of the purchase price (or something else of value) for real property."

    (Note the capitalization of the work "not" above was theirs, not mine)

    Reading further through the text, it's clear that earnest money -- while a good idea -- is not required for either a valid or an enforceable real estate contract.
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    2Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y

    Well what is the something else of value that is considered adequate consideration? Once the deed is signed it generally states the sufficiency of the consideration is "hereby acknowledged" so the consideration only seems to have value up until closing anyway....right?

    If the seller bails on the contract all you could really do is to sue for specific performance, which would likely be a losing proposition in most cases. So does the contract really have any value until the deed is signed in the real world?

    Thoughts?

    0Reply
  • Jerome Harrod II
    OP
    Professional · Baltimore, MD · Member since 2010 · 79 posts · 47 votes
    16y

    I apologize for my late input, I was finishing with a college assignment.
    I really thank you all for your input!
    Kyand was right on the money with what she said. That was exactly what I was asking for, but now since I now know from the conversation that I have to pay earnest money as well. This has become such an invaluable topic for me, just one question.
    Based on what Bryan said above, Not to divert from the main point, If the seller did sign the contract and bails then we sue for performance, how are we in a losing proposition? To my understanding that's basically the seller robbing us of our earnest money! How are we not the victim?

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    16y

    The "losing proposition" stems from the case that the typical motivated seller is distressed, and they have little in assets other than the property. If they are unable to sell the property to you, you sue, you win - but what do you end up collecting if you win?

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    In typical transactions, the seller does not actually get the earnest money. Its held in escrow at a title company. Now, if its a direct contract with a seller, you might hand over $10 and just forget about it if the seller won't sell. If a title co is holding them money, you would get it back if the seller refuses to sell.

    Purchase contracts are, IMHO, one-sided in this respect. You make an agreement and the buyer hands over EM. If the buyer gets cold feet, the seller keeps the EM. If the seller gets cold feet, the buyer gets their EM back, but doesn't get anything for anything they've spent (inspections, appraisals, etc.)

    Now, if you choose "specific performance" in your contract (rather than "liquidated damages"), you could sue the seller, just like the seller can sue the buyer to force a sale if the buyer gets cold feet. Whether you can win such a suit is a different question, and collecting your winnings may be tougher still.

    0Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    16y
    Originally posted by Bryan Hancock:
    Well what is the something else of value that is considered adequate consideration?


    I probably know just enough contract law to be dangerous, but I'm pretty familiar with real estate contracts (and have a few textbooks I can check as reference :), so I'll try to answer these...

    I believe that either "valuable" or "good" consideration is acceptable as part of a real estate contract. So, the "something else" could be something of monetary value or could be something like love, affection and gratitude (which would be an example of good consideration).


    Once the deed is signed it generally states the sufficiency of the consideration is "hereby acknowledged" so the consideration only seems to have value up until closing anyway....right?


    In legal terms, consideration is generally offered to ensure a valid contract. Once the closing has occurred, the contract is no longer executory (i.e., all requirements have been satisfied), so the consideration plays no part in the continued validity of the contract.


    If the seller bails on the contract all you could really do is to sue for specific performance, which would likely be a losing proposition in most cases.


    Actually, in terms of forcing one of the parties to go through with the deal, according to both my attorney and to the RE Contracts textbook I have, it's much more likely that a buyer would win a specific performance suit against a seller than a seller would against a buyer.

    This explains why earnest money is often required by the seller, despite the fact that it is not required as consideration or as any other requirement of a valid contract.


    So does the contract really have any value until the deed is signed in the real world?


    Assuming it's true that the buyer could win a specific performance suit against the seller, yes. And assuming most sellers require earnest money, I would think yes again.

    Now, in a situation where a buyer is unlikely to win a suit for specific performance and where there is no earnest money, while the contract is still enforceable, it's probably worthless.
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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Yes, and local custom will prevail! What is customary in your area.

    And people ask where they put the ten dollars or when they pay it.

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y
    Originally posted by J Scott:


    Now, in a situation where a buyer is unlikely to win a suit for specific performance and where there is no earnest money, while the contract is still enforceable, it's probably worthless.


    Fantastic JScott! It has been a long time since my graduate b-law class so I was starting to think I remembered consideration incorrectly as an element of a K.

    It the real world I would argue that what Jon wrote is correct. The buyer has little recourse in the event of non-performance by the seller because lawyers would extort high fees to cause them to perform. This is compounded when you are dealing with a distressed seller because you, "Can't get blood from a turnip" and they are largely judgment-proof.

    Someone mentioned recording a document once your contract is signed/receipted to cloud title to keep the seller from going around you. I haven't ever had someone sign a 2nd contract after mine was receipted, but this seems like something prudent to do if there is sufficient equity in the deal to merit protecting yourself. This could be something that would help to neutralize the seller getting cold feet so that you didn't have to hire an attorney to cause them to perform. I have no idea how hard this would be for them to remove though.

    Does anyone else do this?

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