Earnest Money - How Much is Enough?
The sale of a property can be divided into the following phases:
- Contract Negotiation
- Option Period
- Post-Option / Pre-Finance Period
- Post-Finance Period
- Closing
Regardless of the state where you are located and the specific form of the contract the purpose of the Option Period is to allow the Buyer to inspect the property and determine if they want to proceed with the purchase. During this period the Buyer can terminate their offer to purchase if the Seller refuses to make the repairs that the Buyer deems necessary. If the Seller refuses to make the repairs that the Buyer requests, of if the repairs are more extensive than the Buyer is comfortable with, the Buyer can terminate the Contract and get their Earnest Money back.
Most Buyers will need financing and most Contracts to purchase a property include a 'Third Party Financing Addendum'. The Third Party Financing Addendum allows the Buyer time to apply for and obtain financing. If they are unable to obtain financing they can get their Earnest Money back. Typically, the Third Party Financing Addendum will allow the Buyer 14-21 days to obtain financing approval for the purchase of the property.
Once the Third Party Financing Addendum 'approval period' has expired the Buyer does not have any contractual right to receive a return of their Earnest Money and if they fail to close they will forfeit the Earnest Money to the Seller. The best insurance that the Seller has that the Buyer will perform on the Contract and complete the closing process is to require that the Buyer put a significant amount of Earnest Money into the purchase of the property.
What is a significant amount of Earnest Money? The answer to that question is based on pain. I suggest that the amount of the Earnest Money that is signficant is an amount that is based on the price of the property and the risk that the Seller is taking. Generally, the Earnest Money should be about 1% of the Sale Price, ranging from a low of about .5% and a high of about 1.5%. If the Sale Price is $100,000 the Earnest money should be no less than $500 and probably not any more than $1,500. If the Sale Price is $500,000 the Earnest Money should be no less than $3,000 and probably not any more than about $7,500.
Where on the range from .5% to 1.5% the Earnest Money amount falls is dependent upon the particulars of the contract and the probability of successful closing and the rist to the Seller. If the Buyer is very qualified and the closing will be quick the amount of the Earnest Money can be reduced to the lower end of the range. If the Buyer is asking the Seller to wait to close longer than about 30 days the Earnest Money should be increased. If the Buyer is wanting the Seller to reduce the price signficantly and wait a long time to close then the Earnest Money should be at the high end of the range, and possibly even a little above the range.
The Seller is taking a big risk by accepting a contract. The Seller is taking their home off of the market and during the Option Period or Finance Period their home will no longer be shown to prospective Buyers by other Agents. This removes the potential of back-up contracts and offers. If the Seller accepts a contract during April that does not close until June the Seller is losing a whole month of 'prime-time' for selling. That is a big risk that the Seller is taking and the Buyer should be making a signficant investment in the purchase to offset that risk.
Many variables should be considered and they must all be given the proper weight based on the particulars of the Seller and Buyer. Here is a quick list of the variables that must be considered by the Seller when determining how much Earnest Money is required:
- Sale Price
- Down Payment
- Creditworthiness and Loan Pre-approval
- Time to closing
- Time of year
- Days on market
- Alternative properties and relative price
- Cost of not selling
- Urgency to sell
- Risk threshold
Ultimately, you want to collect enough Earnest Money that the Buyer will not 'walk-away' from the deal without suffering signficant pain, or at least enough that you, the Seller, can receive some reasonable compensation for the fact that your home has been taken off of the market during the Contract period prior to the default of the Buyer. Keep in mind that the ability to recover the Earnest Money is not a foregone conclusion even if the Buyer defaults and that it may take many months to receive the Earnest Money and that to facilitate the receipt of the Earnest Money you may end up negotiating to accept only a portion and release the remainder to the Buyer.
If you have any questions about this article please call Lee Thurburn at 972-470-5888.
- Contract Negotiation
- Option Period
- Post-Option / Pre-Finance Period
- Post-Finance Period
- Closing
Regardless of the state where you are located and the specific form of the contract the purpose of the Option Period is to allow the Buyer to inspect the property and determine if they want to proceed with the purchase. During this period the Buyer can terminate their offer to purchase if the Seller refuses to make the repairs that the Buyer deems necessary. If the Seller refuses to make the repairs that the Buyer requests, of if the repairs are more extensive than the Buyer is comfortable with, the Buyer can terminate the Contract and get their Earnest Money back.
Most Buyers will need financing and most Contracts to purchase a property include a 'Third Party Financing Addendum'. The Third Party Financing Addendum allows the Buyer time to apply for and obtain financing. If they are unable to obtain financing they can get their Earnest Money back. Typically, the Third Party Financing Addendum will allow the Buyer 14-21 days to obtain financing approval for the purchase of the property.
Once the Third Party Financing Addendum 'approval period' has expired the Buyer does not have any contractual right to receive a return of their Earnest Money and if they fail to close they will forfeit the Earnest Money to the Seller. The best insurance that the Seller has that the Buyer will perform on the Contract and complete the closing process is to require that the Buyer put a significant amount of Earnest Money into the purchase of the property.
What is a significant amount of Earnest Money? The answer to that question is based on pain. I suggest that the amount of the Earnest Money that is signficant is an amount that is based on the price of the property and the risk that the Seller is taking. Generally, the Earnest Money should be about 1% of the Sale Price, ranging from a low of about .5% and a high of about 1.5%. If the Sale Price is $100,000 the Earnest money should be no less than $500 and probably not any more than $1,500. If the Sale Price is $500,000 the Earnest Money should be no less than $3,000 and probably not any more than about $7,500.
Where on the range from .5% to 1.5% the Earnest Money amount falls is dependent upon the particulars of the contract and the probability of successful closing and the rist to the Seller. If the Buyer is very qualified and the closing will be quick the amount of the Earnest Money can be reduced to the lower end of the range. If the Buyer is asking the Seller to wait to close longer than about 30 days the Earnest Money should be increased. If the Buyer is wanting the Seller to reduce the price signficantly and wait a long time to close then the Earnest Money should be at the high end of the range, and possibly even a little above the range.
The Seller is taking a big risk by accepting a contract. The Seller is taking their home off of the market and during the Option Period or Finance Period their home will no longer be shown to prospective Buyers by other Agents. This removes the potential of back-up contracts and offers. If the Seller accepts a contract during April that does not close until June the Seller is losing a whole month of 'prime-time' for selling. That is a big risk that the Seller is taking and the Buyer should be making a signficant investment in the purchase to offset that risk.
Many variables should be considered and they must all be given the proper weight based on the particulars of the Seller and Buyer. Here is a quick list of the variables that must be considered by the Seller when determining how much Earnest Money is required:
- Sale Price
- Down Payment
- Creditworthiness and Loan Pre-approval
- Time to closing
- Time of year
- Days on market
- Alternative properties and relative price
- Cost of not selling
- Urgency to sell
- Risk threshold
Ultimately, you want to collect enough Earnest Money that the Buyer will not 'walk-away' from the deal without suffering signficant pain, or at least enough that you, the Seller, can receive some reasonable compensation for the fact that your home has been taken off of the market during the Contract period prior to the default of the Buyer. Keep in mind that the ability to recover the Earnest Money is not a foregone conclusion even if the Buyer defaults and that it may take many months to receive the Earnest Money and that to facilitate the receipt of the Earnest Money you may end up negotiating to accept only a portion and release the remainder to the Buyer.
If you have any questions about this article please call Lee Thurburn at 972-470-5888.
posted by DallasFlatFee at 9:57 AM
0 Comments:
Post a Comment
<< Home