The first time you bought a home, you likely dealt with an earnest money deposit. When you made an offer, your real estate agent probably asked for a check and recommended a specific amount. But, what about investors? In other words, if I’m buying an investment property, how much earnest money should I put down?
Earnest money serves as a consideration provided by the buyer to the seller. It lets the seller know the buyer’s seriousness about the deal. When buying a property from the MLS, you’ll likely need to put $500 to $2,000 down. With off-market properties, sellers typically require far less ($50 to $100).
I’ll use this article to provide some more earnest money details and considerations.
What is Earnest Money?
Before discussing how much earnest money to put down, I want to provide some background on what earnest money actually represents. Legally speaking, earnest money serves as consideration, or value, in a contract between a buyer and seller. Practically, the buyer provides earnest money to the seller as a good-faith commitment. In other words, this money lets the buyer say to the seller, yes, I am serious about moving forward with this purchase, and here’s some money to prove it.
Additionally, this money takes into account the length of time a home sale can take. On average, a home purchase including mortgage financing takes between 30 to 45 days after signing a contract to actually close. This is a long time for a seller to wait on trust alone. Providing earnest money offers the seller a guarantee of sorts. This guarantee gives the buyer time to handle closing-related activities (e.g. secure financing, get an appraisal, conduct necessary inspections, etc.).
Typically, the buyer provides his or her earnest money deposit after signing the sales contract with the seller. While you can provide this money directly to the seller, I highly advise against this. You should place this money in escrow with a title company or real estate attorney until closing.
So what happens to this money after you close on a purchase?
Assuming you close the deal, this deposit gets credited to the purchase price. In other words, if you provide $1,000 in earnest money, when you actually close, the agreed-upon purchase price will be reduced by that $1,000. However, things can become slightly more complicated if you don’t close on the deal, which I’ll discuss in the next section.
Important Tips: Contract Deadlines and Earnest Money
When you purchased a home, your real estate agent probably sent you a bunch of reminders about different deadlines. You may not have known it at the time, but these deadlines directly relate to the earnest money. More precisely, if you back out of a contract before these deadlines, your earnest money will be returned to you. However, if you decide to back out of a deal after these deadlines, the seller will keep the earnest money. In this way, these funds compensate the seller for wasted time if the buyer backs out of a deal in bad faith.
While more complicated closings may have additional deadlines, most residential property deals include the following standard deadlines:
- Inspections/evaluations (a.k.a. due diligence): This is the timeframe buyers have to conduct full property inspections. If they find an issue with a property that they don’t like, they can ask the seller to fix it. Or, if they so desire, a buyer can back out of the deal with earnest money, as long it’s before this deadline.
- Loan approval: This is the deadline by which buyers need to secure their financing. In other words, if buyers aren’t approved for a mortgage by this deadline, they can back out of a deal with an earnest money refund. For this reason, many sellers won’t accept offers from buyers who haven’t already been pre-approved for a loan.
- Appraisal: After loan approval, the lender will require a formal appraisal. Lenders want to confirm that they’re not lending more than a home’s appraised value. As a result, if a property appraises for less than the contract price, buyers need to A) pay cash for the difference, B) request to lower the contract price, or C) back out of the deal. If buyers choose to back out before this deadline, they will receive their earnest money.
The above deadlines protect the seller and buyer in a transaction. But, as with all legal transactions, you’ll want to make sure that these deadlines are written into the contract.
How Much Earnest Money to Put Down – MLS Properties
After explaining earnest money, I still need to address how much you should actually put down as a buyer. The answer depends on what sort of property you’re pursuing. I’ll begin with properties listed on the MLS.
When a seller lists a property on the MLS, it means he or she is represented by a real estate agent. Generally speaking, listing on the MLS requires a licensed real estate agent (though exceptions exist). And these agents typically encourage the sellers they represent to ask for significant earnest money deposits.
In theory, the more earnest money a buyer provides, the more committed he or she is to a deal. Sellers’ agents don’t want to waste their clients’ time. Instead, they want to make sure any buyer plans on actually closing. With this in mind, most buyers will put down between $500 to $2,000 of earnest money on an MLS-listed property. However, in particularly hot seller’s markets, it’s not uncommon for buyers to put down far more to demonstrate that they’re serious about a purchase.
How Much Earnest Money to Put Down – Off-market Properties
As a real estate investor, I highly recommend pursuing off-market properties, not ones listed on the MLS. In addition to finding better deals with less competition, you’ll need to put down far less in earnest money.
As stated above, real estate agents encourage their seller-clients to seek large earnest money deposits. With off-market properties, sellers don’t have agents representing them, so no one’s encouraging these large deposits. Instead, most off-market deals include relatively small deposits. On average, I’ll put down between $50 to $100 in earnest money on an off-market deal—far less than equivalent MLS-listed deals.
Final Thoughts
When figuring out how much earnest money to put down, no single answer exists. Instead, investors need to gauge the specific deal while following general rules of thumb. For properties listed on the MLS, the seller’s agent will likely encourage a deposit of $500 to $2,000—though sometimes far more. On the other hand, off-market deals typically require far smaller earnest money deposits, with most sellers willing to accept $50 to $100.
For real estate investors, this difference in the average deposit can add up over time. As deposits, the earnest money is cash out of your pocket. That is, you’re not financing this money with a mortgage. Investors will want to provide the smallest earnest money deposit that a seller will still accept. This is far easier to do this when investing in off-market properties.
Learn how to make money flipping real estate with us by attending our next webinar.
COMMENTS