The one thing I want to cover today is Earnest Money Deposits. I had an individual contact me about “Earnest Money Deposits”. The Investor asked me: “How do you get the funds for earnest money deposits if you don’t have those particular funds available to you right now or when you make an offer?”
I’ve been in this situation before folks, and some of you really might be in this very same position right now like when I first started in 2008. I was living on unemployment checks, so having earnest money deposit funds to invest was very much not an option for me at that time.
I want to share this information with you today about some of the things that I had to do in my business in the beginning to really make things work, and to really structure things in a way, especially on a purchase and sales agreement that would be in your favor as a new or struggling investor to really get things going.
NOTE: You don’t necessarily have to use your own personal funds for the earnest money deposit required for some of the offers you make on potential deals.
Structuring Deals Without Using Your Own Funds For Earnest Money Deposits
First thing, that I want to let you know is if you do not have funds, the strongest recommendation that I can give to you would to start out wholesaling deals if you do not have the funds to invest or even the money for small earnest money deposits.
You need to have a buyers list to really make this work, and let me explain why. When you get a contract together, say it’s a rock solid deal. You have on your contract a deal for $30k and you know that you could quickly flip it to another investor, for let’s just say $45k.
Most sellers require an earnest money deposit or your agent may ask you to include earnest money to make your offer look serious.
Below are a couple options that you can do to solve the "earnest money dilema" once you get the deal under contract.
Collecting Earnest Money Upfront From Your Buyer
You could allow yourself, let’s just say three to five business days to get those earnest money deposit to that seller. Here is how…
What I typically do is I don’t give those funds to the seller. I’ll place those funds into my escrow account with my title company (company that will close the deal). Those funds get held in escrow until we actually close, okay? Why give myself those business days in order for me to setup this transaction properly?
Well what I’m doing is I’m having my end buyer give me what’s called a, “hard deposit.” A hard deposit means it’s pretty much non-refundable, the only time I give those funds back from a hard deposit standpoint is if something comes back bad during the closing process.
For example if I didn’t disclose something properly within my purchase and sales agreement, such as an inspection happens and there’s maybe termite damage, or I didn’t disclose something possibly with the foundation.
If that’s the case I’m going to give the funds back, and I highly encourage you to operate the same way within your business because you don’t want to get an end buyer, especially a cash investor upset over piddly amounts of money.
If I’m going to be at $45K on my second transaction where I’m doing an A to B, B to C transaction -- what’s going to happen is I’m going to go ahead and get my end buyers earnest money funds. Typically what I like to do to receive the funds upfront - especially on deals below a $100K - is I’m going to request $2K as a hard deposit. The main reason why I request that amount is it really gets that individual committed to buying your deal, okay? If you ask for $250, or even $500, they may not be fully committed. If you ask for $2K it gets a much higher committed person involved. I get the end buyers funds, so I can do a hard deposit with the escrow/title company.
NOTE: What you can do at that point is you could take those funds, you could put it in your title companies escrow account, and then at that instance have the title agent send the money from your escrow account to your seller. Your A to B transaction will consist of $500 in pledged earnest money. You could let your seller know by a phone call or email: “Hey, you can verify that the earnest money deposit has been put in place for our transaction with the title company.” They could verify that right then and there, and then you’re good to go from that standpoint.
Second Option That You Can Use Without Ever Using Your Own Funds
The second option out of the two that I prefer, and can be easily duplicated within any business. The one thing that I would tell you that you could do to add an addendum section on your purchase and sales agreement that “earnest money deposit funds will be deposited three business days prior to closing.” That allows you time to go ahead and find that end buyer.
Again, I strongly suggest that you put together your buyers list (for someone brand new, you ideally want to have a list of ten solid investors) before you get to that situation. You want to have your buyers list put into play because as soon as you get a deal you want to be able to get that deal quickly under contract with your end buyer. That’s what I recommend, that’s how I would recommend that you put the deal together.
Protecting Yourself From a Bad Apple of a Deal
You also want to be able to have some outs. Make sure there’s some sort of an inspection out that you can have on your contract where the earnest money deposit will be refunded back to you if something does pop up - like something from the appraisal or inspection.
Those are the things that I would recommend that you definitely have in place to ensure that you are making a proper deal. The other thing that I would recommend here is by having the statement in there on your purchase and sales agreement that allows you to really be in a position that allows you to not use any of your own funds. It’s always wise to include a financing addendum to allow yourself time to secure funds.
The goal is to not use any of your own funds, and use your end buyer’s funds in a legal way. By you having them give you earnest money for that transaction, that’s essentially giving you “earnest money deposit” on the B to C, not the A to B. You will take those funds that you just received and give them to your A to B transaction.
Again, I’m not an attorney, I’m not giving you legal advice. I just wanted to share some quick notes explaining some of the things that I do, or have done when it comes to earnest money deposits.