By William Bronchick, Real Estate Coach and Attorney
In real estate investing, a buyer will usually put up earnest money to bind the contract and show that he is a serious buyer. Most sellers ask for the earnest money deposit because they are afraid of tying up the property and rejecting other potential buyers.
How Much is Necessary?
No specific amount of earnest money is required. I have used a cup of coffee as consideration for a contract. In fact, if the transaction involves the buyer simply taking over a loan and the property has no equity, it may be appropriate for the seller to give the buyer consideration. As a rule of thumb, the buyer wants to put down as little as possible ($50 to $500), and the seller should get as much as possible ($1000 to $5000). Of course, the amount of earnest money will depend on the motivation of the parties, the purchase price, and the length of time until closing.
Do not confuse earnest money with consideration. In a bilateral contract, a promise to buy can be the consideration for a promise to sell. With an option, consideration is much more important. A seller’s promise to sell is not induced by a promise to buy, but rather a payment of option consideration.
If you are afraid of losing your earnest money as a buyer, you may consider offering a promissory note as earnest money. This, of course, requires the seller to sue you to collect if you default. A seller may be reluctant to accept a promissory note rather than cash. As a compromise, I have often structured contracts where the seller received a promissory note as earnest money, which was paid in full after the property was inspected and the buyer received a loan commitment (but before closing).
Who Should Hold Real Estate Contract Earnest Money?
A big issue for the parties is who should hold the earnest money deposit in escrow. Theoretically, the escrow agent (the person holding the earnest money) must release the funds to the seller if the buyer breaches and to the buyer if the contract is canceled. However, the escrow agent will not usually release the funds without the permission of both parties, even in the face of a clear breach or cancellation. Furthermore, if the escrow agent is the listing broker, he may side with the seller and not release the money (the listing broker has an incentive to keep the earnest money since his listing agreement usually gives him part of the forfeited earnest money deposit as a commission). The seller would obviously prefer to have his broker hold escrow. The buyer would prefer that a neutral or “buyer friendly” title or escrow company hold the earnest money. An added note that having a real estate attorney, real estate coach, or real estate mentor on your team can pay dividends!