Common earnest-money deposit mistakes that some buyers make

DEAR MR. MYERS: The housing market in our area is pretty hot, with most sellers getting multiple offers. We made an offer to buy a house with a $10,000 earnest-money deposit, and the seller agreed to accept it, provided we cancel our loan contingency. This doesn’t seem like a deal-breaker because we already are pre-approved for the mortgage. Should we go ahead and agree to drop the contingency?

ANSWER: No, don’t even think about deleting the loan-contingency clause that you wisely included in your original offer. It’s one of the most common mistakes that buyers make, especially when they fall in love with a property in an area where homes are selling faster than an Indy car can race.

A February report by the National Association of Realtors polled several sales agents and lenders about the biggest earnest-money deposit mistakes that buyers make. I’m devoting this entire column to sharing those findings and offering some guidelines.

The first mistake is failing to understand what an earnest-money deposit, or EMD, actually is. It’s an upfront deposit that shows that you’re serious about completing the proposed sale.

Most of the time, it’s an amount that’s equal to 1 or 2 percent of the purchase price. But today (especially in red-hot markets), it’s not unusual to see buyers offering a deposit that’s equal to five or even 10 percent of the sale price.

The EMD, sometimes called a “good-faith deposit,” typically is held by the seller’s broker, a title company or the closing attorney or escrow officer who will handle all the paperwork. It’s used as a credit toward the buyer’s down payment and closing costs.

Q: We’re definitely earnest about buying a particular house, so why is it a big deal if we agree to cancel our loan contingency?

A: The loan contingency will let you cancel the sale and get your deposit back if you can’t line up a mortgage to complete the transaction.

Savvy buyers always get pre-approved for a loan before they begin their house-hunting trek. But the bank can rescind its pre-approval for any number of reasons, from the sudden loss of a co-borrower’s job to a lowball appraisal that suggests that the buyers are paying too much for the target property.

If the pre-approval is canceled and there’s no loan contingency, the seller can keep some or all of the buyer’s EMD as compensation for the busted deal.

Q: I made an offer that included a loan contingency. The seller was OK with that, but he countered with an offer that includes a clause that states the deal must close by the 14th of next month. Would I lose my deposit if I can’t meet his closing deadline?

A: Yes, you could. Sellers often include a so-called timeliness clause in their counteroffers, usually because they’re buying a new home of their own and don’t want to get stuck with two monthly mortgage payments instead of one.

Check with your real estate agent or the company that will oversee the closing to determine whether the deal can realistically be completed by April 14. Remember that sales are at near-record levels in many parts of the nation, so transactions are taking longer to close: One or two hiccups along the way could push the closing back a week or more, which in turn could place your EMD at risk.

Q: I have checked out several bank-owned foreclosures in my area. All of them would require me to make a nonrefundable deposit. Is this typical?

A: Yes. Lenders don’t want to waste time on lookie-loos who think that they’re ready to purchase a foreclosure after watching a few television shows or attending a weekend seminar, so the nonrefundable EMD helps to ensure that only serious buyers will come forward.

It’s important to note that most bank-owned homes are sold on an “as-is” basis, meaning that you can’t cancel the sale and get your deposit back if problems are discovered after your purchase offer is accepted. So, make sure you have a professional home inspector check out the property before you sign on the dotted line.

Q: What happens if a buyer cancels a sales contract for a legitimate reason, such as a home inspection that turns up a lot of hidden defects, but the seller refuses to return the EMD?

A: When a real estate deal falls apart, both the buyer and the seller must sign a document that officially renders the original sale null and void. If the two sides can’t agree on the return of some or all of the deposit, the buyer can refuse to sign the cancellation agreement.

Such a refusal puts a cloud on the home’s title, essentially making it almost impossible for the seller to look for another buyer until the EMD problem is resolved. That’s a simple but powerful weapon that the buyer can use to get the deposit returned.

David W. Myers’ column is distributed by Cowles Syndicate Inc.