EI don’t think that earnest money seems to confuse many new real estate investors. They hear the phrase and understand the general concept, but they don’t quite grasp all the details. And, people often – incorrectly – believe they need a ton of earnest money to buy a home. As such, I’m frequently asked: Ryan, what do you need to do if you don’t have earnest money?
Earnest money is negotiated between seller and buyer, so there’s no set amount. I recommend pursuing off-market properties rather than those on the MLS, as these sellers typically accept smaller deposits. But, if you don’t have enough earnest money, several financing strategies do exist.
I’ll discuss earnest money in this article – and what to do if you don’t have enough. Specifically, I’ll cover the following topics:
- What Is Earnest Money?
- Earnest Money with MLS Properties
- Earnest Money with Off-Market Properties
- Raising Money Through Wholesaling
- Zero-Down Financing Options
- Gap Financing to Cover Earnest Money Requirements
- Using the Same Earnest Money Deposit for Multiple Offers
- Final Thoughts
What To Do If You Don’t Have Earnest Money
Prior to discussing what to do without earnest money, I want to briefly define it, as much confusion exists with the term. Most importantly, sellers and buyers negotiate earnest money deposits amongst themselves – there isn’t a set amount for buyers. In other words, an agent may suggest $1,000 (or some other number), but the amount ultimately comes down to what the buyer and seller mutually decide.
Having said that, an earnest money deposit serves as a buyer’s good faith to the seller that he or she plans on actually buying the home. This money and associated good faith then provides the buyer extra time to take care of different home buying tasks (e.g. confirm financing, run title searches, conduct home inspections and appraisals, etc.).
When making an offer on a home, buyers can either A) attach an earnest money deposit to the offer, or B) deliver it once they sign the contract. Either way, earnest money is a deposit, meaning that, once you close on the property, you’ll see the deposit funds applied as a credit towards your purchase price. Generally speaking, a settlement agent or company holds a buyer’s earnest money in escrow until closing. This way, buyers can easily receive earnest money refunds if they back out of a deal in accordance with contingency clauses in the contract.
Earnest Money with MLS Properties
Broadly speaking, investors will face two different earnest money scenarios: with MLS properties and with off-market properties.
When properties are listed on the MLS, they face a tremendous amount of competition. Primary home buyers want them and investors do as well. This means that sellers often have the upper hand in negotiations with buyers, even when broader market factors favor buyers in general.
Due to this upper hand, agents representing sellers tend to encourage large earnest money deposits, basically because they can. Simply put, if you as an investor put an offer on an MLS property and refuse a large earnest money deposit, sellers likely have another buyer on deck who will put down that deposit.
In this environment, investors can usually expect an earnest money requirement ranging from $1,000 to $2,000. In extremely hot seller’s markets, it’s not uncommon to see buyers offering earnest money in excess of $10,000 – anything to have your offer selected. For many investors, these requirements can absolutely be cost prohibitive.
Earnest Money with Off-Market Properties
The other scenario investors face involves earnest money deposits with off-market properties. These are properties that owners have not listed for sale but may want to sell. More precisely, investors look for buyers who A) have equity in their home, B) need to convert that equity into cash, but C) have property issues/damage that prevent it from qualifying for traditional financing.
Put simply, these owners need cash but don’t want to pay for a major repair on their property to get it ready for sale. Enter real estate investors as problem solvers. Essentially, investors offer a win-win situation. Win 1: investors buy the home without it needing to qualify for traditional financing, quickly putting needed cash in the hand of the owner. Win 2: investors typically get great deals on these types of properties.
NOTE: If interested in this sort of marketing strategy, our Investor’s Edge software can help tremendously. This tool has property data on over 160 million potential deals, providing investors key information on market comps and current equity, arming you with the tools to find these sort of motivated off-market owners.
As these off-market properties don’t A) have a lot of (or any) competition, and B) have agents representing sellers to encourage large deposits, I’ll typically offer far less in terms of earnest money. Depending on the specific deal, I recommend offering between $25 to $100.
For new investors, if you can’t afford a $25 to $100 earnest money deposit, you probably shouldn’t be investing in real estate. Regardless of financing, investors should always have between $3,000 to $5,000 in cash on hand. This lets you cover incidentals as they arise (e.g. inspections, appraisals, repairs, etc.). So, if you need this initial capital, before diving into fix & flip or BRRR deals, consider raising funds through another investment strategy.
Raising Money Through Wholesaling
Fortunately, one such strategy exists to raise money with little to no initial capital: wholesaling. This can be a great way for new real estate investors to A) raise money for future purchases, and B) learn how to properly analyze a potential deal.
With wholesaling, you don’t actually purchase homes, so you don’t need to qualify for loans. Additionally, if you structure the deal the right way, you can push earnest money off on someone else. This investment strategy lets you make money regardless of cash on hand. As a result, it represents a great approach for new real estate investors as they work on building capital.
As stated, wholesalers don’t purchase investment properties. Instead, wholesalers find off-market properties, and they enter contracts to purchase these properties. Rather than actually close on the purchases, they assign the contracts to a third party, typically a fix-and-flip investor. And, they assign these contracts for a fee. For instance, a wholesaler may put a property under contract for $100,000 but assign it to a fix & flip investor for $110,000, pocketing a $10,000 profit in the process. In a nutshell, wholesalers find deals, connect the sellers with investors, and collect a fee in the process – all without the headaches of closing on the purchase, rehabbing the property, and selling it.
In addition to putting money in your pocket, wholesaling teaches investors the critical skill of analyzing potential deals. When you look for properties as a wholesaler, you need to think in terms of what a fix & flip or BRRR investor wants in such deals. If you don’t meet their investment criteria, you won’t have anyone to whom you can assign a contract. Accordingly, if you treat wholesaling as both a capital-raising endeavor and an educational experience, a few deals will give you the know-how and earnest money for your own fix & flip or BRRR deal.
If this strategy interests you, our Investor’s Edge software once again proves extremely useful. Successful wholesaling depends on having a network of willing buyers to take contracts off your hands. This software includes a massive network of buyers located all over the country.
Zero-Down Financing Options
While I stand by my belief that all real estate investors should keep several thousand dollars in cash at all times to cover incidentals, that doesn’t mean zero-down financing options don’t exist. For investors tight on cash, this means that if you can cover an off-market earnest money deposit and keep a little cash on hand, you have options to finance the rest of the deal. These options hinge on hard money loans.
When you use traditional financing (i.e. your standard 30-year mortgage) to purchase a home, lenders review all of your “soft” assets – credit score, income, debt-to-income ratios, assets, etc. Essentially, these lenders want to confirm that you have the wherewithal to make your monthly mortgage payments.
On the other hand, when you purchase a distressed property with a hard money loan, these lenders look solely at the “hard” asset, that is, the property itself. More precisely, hard money lenders look at a property’s after-rehab value, or ARV. When investors purchase a distressed property, the current value doesn’t matter nearly as much as what the property will be worth following the rehab period. To determine this estimated value, investors and hard money lenders work with specially trained appraisers who can combine a property’s current value, its contractor-supplied rehab bids, and market comps with similar renovations to project a property’s ARV.
Once appraisers report this projected value, hard money lenders provide loans based on a percentage of the ARV. While each lender has its own approach, Do Hard Money will lend 70% loan-to-value (LTV) based on ARV. For example, say an appraiser projects a home’s ARV at $300,000. In this case, we’d lend $210,000 ($300,000 ARV x 70% LTV).
For investors looking for a zero-down deal, this $210,000 represents the “magic number.” If investors can find a home with purchase, rehab, and sales-related costs less than $210,000, they can finance the entire deal with the hard money loan. These deals can be very difficult to find, but they do exist. Yet, as I’ve emphasized above, investors should still have some cash on hand for incidentals and potential emergencies that need to be quickly paid out of pocket.
Gap Financing to Cover Earnest Money Requirements
To reiterate, if you don’t have the $25 to $100 to cover the earnest money deposit for an off-market property, you shouldn’t invest in real estate. But, occasionally investors do find decent deals on the MLS. Or, a buy-and-hold investor may potentially not mind paying retail for a property, comfortable that a rental property will still command significant long-term returns, even without a deep purchase discount.
In these situations, you may find yourself needing to pay a large earnest money deposit. If you A) don’t have the cash for such a deposit, or B) would prefer to keep that cash in reserve, options exist to finance these deposits. Known as gap financing, this technique provides investors the funds to make a deal happen. Sometimes this means covering the necessary gap between capital and down payment requirements, but it could also mean covering an earnest money deposit until securing long-term financing or selling a property. While not an all-inclusive list, here are a few strategies for gap financing a large earnest money deposit:
Credit Card Financing
Credit card companies want your money. As such, if you’re a responsible borrower, they’ll provide you pretty good personal loan options. Say you have a $25,000 limit on your credit card, but you only use $2,000 of it every month, always paying it off on time. There’s a good chance the card company will offer you a relatively low interest personal loan for the difference between the credit you regularly tap and your limit. This can be an outstanding gap financing strategy.
Find a Business Partner
Alternatively, you can seek a business partner. Plenty of people A) want to invest in real estate, but B) don’t have the time or experience to do so. If someone has money to invest, you can potentially bring them on as a limited – or “money” – partner. These individuals provide funds, have no role in the day-to-day operations, and receive a return on their investment. Yes, you’ll need to sacrifice a portion of your returns. But, if it makes the difference between funding a deal or not, bringing on a partner can be a great option.
HELOC
Home equity lines of credit, or HELOCs, are another great gap financing strategy. Typically, investors tap the equity in their primary residences. Assume you have $50,000 in equity in your property. A lender may not extend a HELOC for that entire amount, but even if you secure a $25,000 HELOC, this gives you a tremendous amount of gap financing flexibility. And, with HELOCs, you only pay interest on the money you draw. Once you repay the outstanding balance, you don’t need to pay interest.
Business LOC
Functionally, a business line of credit (LOC) acts the same as a HELOC. However, rather than secure the credit against your primary residence, banks use your business’s operations to secure a business LOC. Obviously, this option only exists for investors with a business. But, if you have a successful business, a LOC secured by its operations can be an outstanding gap financing option.
All of these strategies provide you flexibility in raising earnest money funds. If faced with a competitive market and a deal you want, you may need to pay a large deposit, and finding ways to finance this can help save your cash for other uses.
Using the Same Earnest Money Deposit for Multiple Offers
Technically speaking, investors can use the same earnest money for multiple offers. In competitive markets, I frequently make offers on multiple properties knowing that most sellers won’t accept. And, you can structure an earnest money payment one of two ways in an offer. You can include it in the offer, or you can state that you’ll place it in escrow several days after an accepted offer.
If you use the latter approach, you can make offers on a dozen properties without paying a single earnest money deposit. Instead, you only submit the money to escrow with your settlement company after a buyer accepts an offer. With this technique, you don’t need a dozen earnest money payments – you need a single one to cover an accepted offer. When working with MLS properties requiring $1,000 to $2,000 (or more) for earnest money, this approach can mean the difference between making an offer on one deal or multiple ones.
NOTE: I mentioned it above, but it’s important enough to reiterate here: never give your earnest money deposit directly to the seller. Instead, always place it in an escrow account, typically with your settlement company. That way, if you need to back out of a deal during a contingency period, you don’t need to fight with the seller to claw back the earnest money. Instead, you have a neutral third party who will abide by the terms of the contract and promptly return your funds.
Final Thoughts
The amount of earnest money you need depends on where you find a property. If on the MLS, you’ll typically need $1,000 to $2,000. If you don’t have or don’t want to spend this cash, gap financing techniques exist. If making an offer on an off-market property, you’ll likely only need $25 to $100 in earnest money. If you can’t come up with this amount, you shouldn’t invest in a property. Instead, you should consider an alternative strategy – like wholesaling – to raise the capital to begin a fix & flip or BRRR approach.
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