HOW BIG SHOULD THE ESCROW DEPOSIT BE?
August 15, 2017 | Richard Sites
When is Enough, Enough? That Depends on Who You Ask
In a residential real estate transaction, there is a concept called “Earnest Money”. Sometimes this is referred to as an escrow deposit. What is it’s role in the deal and how big should it be?
Let’s take a look at the pros and cons of a big deposit and the risks to the buyer and seller.
When Is The Deposit Required?
In the past, it was customary for a buyer to place a “good faith deposit” with their agent at the time their offer was submitted to the seller’s agent. It doesn’t work like than anymore.
Now, the standard FAR-BAR contract contains language that allows the deposit to be split into two parts and each part has a different time frame attached to it. First, earnest money no longer needs to accompany the offer it may be deposited within three days of the effective date of the contract.
This means negotiations will take place and when & if a deal is agreed upon, only then the buyer will make their first deposit. This has one main advantage. It keeps the buyer’s funds from being tied up by the company holding the escrow deposit until the funds have cleared or as they are termed today “collected funds”.
Companies holding escrow money have every right to hold the funds until they clear to protect themselves from check kiting. However, some firms used to hold funds for 30 days which meant the buyers, if they could not reach a deal, had their money tied up and could not buy another property.
The Second Deposit
This second part of the deposit is typically made the day after the inspection or due diligence period ends. This way buyers have now made a concrete decision to move forward with the deal so they make a second deposit.
When these two sums are combined, the seller now has the escrow deposit. However, this deposit is still returnable to the buyer if they fail to secure mortgage financing or fail to meet any other criteria like attorney approval or an appraisal contingency.
What Is The Risk To The Buyer?
There is no risk to the buyer of losing the deposit when time frames are adhered to strictly. Florida is a “time is of the essence” state which means the time frames specified in the contract are firm and if not adhered to can place either party to the deal in jeopardy. So sticking to the time frames ensures there is no risk of losing the deposit.
Unfortunately, most buyers think their deposit is at risk so they want to make a small one. This is a fundamental mistake. Here’s why.
If you are serious about buying a particular house, and if you know that your deposit is not at risk, putting just a small amount down signals the seller that you may not be as serious as you really are. Why?
If you make a small deposit, you might be willing to forfeit it if it suits your needs. Here’s an example:
Buyer makes a small deposit ($2,000) on a home in a particular neighbor. When they made the deal it was the only house on the market. After the deal is reached another very similar house comes on the market in the same neighborhood priced $10,000 less than the contracted home.
You might see how the buyer would be willing to sacrifice their deposit in order to potentially save thousands more by buying the other house. You can see how their perspective would change if they had a large deposit down on the first house.
So What Should You Do When Selling?
You should ask for a full 10% down before agreeing to a deal. Now, it might turn out that the buyer does not have 10% or they could be getting an FHA loan where just 3.5% was required. In these cases, you should evaluate the strength of the buyer’s offer in light of the smaller deposit.
When a buyer has a 10% deposit the chances they will walk on the deal fall off dramatically. Now there are some exceptions.
Multi-Million Dollar Properties
On very expensive homes, a 10% deposit is usually not committed. Someone buying a $5,000,000 home probably isn’t going to make a $500,000 deposit. But doesn’t a large deposit mean they are serious?
Yes, but for folks with this kind of money they may walk on the deal and just sacrifice the deposit. I know of a case where this happened on a $3.5 million sale recently. The buyer simply changed his mind and gave up the deposit.
The Take Away
Big deposits make for secure deals. If you are buying, make the biggest one you can afford. If you are selling, make sure to ask for 10% down if possible.
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