When is enough, enough?
When it comes to selling real estate there is no standard, acceptable amount of earnest money to accompany an offer. First let’s examine what earnest money is. Earnest money is also referred to as “good faith” money. In other words, it is a payment made by the buyer at the time an offer to purchase is written that demonstrates to the seller, they fully intend to close on the sale of the property. The buyer is saying, “I’m really interested and if I change my mind and decide not to close this transaction, for any reason other than certain contingencies specified within the purchase agreement, I understand I will forfeit my earnest money.” Earnest money, or good faith money, is held in escrow until closing, at which time is applied to the total purchase price.
In Alabama, an offer to purchase is not binding on either party (the buyer nor seller) until the offer has been accepted by the other party. For practical purposes let’s assume the buyer is making an offer to purchase. EXAMPLE; A potential buyer and their agent views a property listed for sale at $225,000. The buyers want to write an offer for $200,000. The agent representing the buyer asks them for $1,000 earnest money. Is this a sufficient amount?
My answer to this question is it depends on whom the agent represents. An Alabama real estate agent has a fiduciary responsibility to represent their client’s best financial interests. Therefore the agent representing the buyer wants the buyer to take no more chances than necessary; to protect the buyer should they change their minds about closing on the transaction, and be forced to forfeit their earnest money. On the other hand, has the selling agent properly explained to the buyer that the amount of earnest money is actually a showing of their sincere desire and capability to purchase the property?
Let’s continue this example by looking at the offer from the listing agents view point. The listing agent also has a fiduciary responsibility to represent the seller’s best financial interest. The listing agent provided the seller with current market values when they first discussed putting the property up for sale. Based on factual data supplied to the seller by the listing agent, the seller decided that pricing their property for $225,000 was comparable to other like properties in their immediate area. The seller also took into consideration that this price might produce a buyer quicker than a higher price. The listing agent carefully reads through the entire offer and everything seemed to be acceptable except the price; which is considerably less than market value. The listing agent calls the seller to set an appointment to present the offer.
The listing agent thoroughly explains the offer to the seller. The seller isn’t excited about the price offered but seems to be considering it because they are uncertain how long it might take to get a higher offer. The agent explains that they can counter the offer, but according to Alabama law, either party can withdraw their offer up until such time as it has been accepted and signed by both parties. If the seller counters, the buyer is no longer obligated and can walk away and lose nothing. The seller then says, “They aren’t very interested anyway because they would only lose $1,000 if they changed their mind without a legal excuse. Are you sure this buyer can qualify for a loan? You have to pay down that much to buy a car. I think we paid closer to 10% earnest money when we bought .They are trying to steal our property without showing any real commitment.”
The seller just made a strong statement that the listing agent should have made himself when he presented the offer. In keeping with my fiduciary responsibility to the seller, I would ask myself if this was a viable offer to begin with, but according to Alabama law I have to present the offer and allow the seller to make that decision; unless the seller had instructed me to only present viable offers.
Just for the sake of this example, how would the seller have reacted had the earnest money amount been $5,000? Would that amount have sent a stronger message to the seller that he was serious and wasn’t going to change his mind? I think so.
Now let’s take this example one step farther. The listing agent has a fiduciary responsibility to the seller to explain to them that should the buyer change their mind and not close the transaction, without legal cause, the earnest money deposit is all the buyer would have to forfeit. Unfortunately, some real estate agents never explain the importance of the earnest money amount, nor how it is handled. Especially in today’s market, most buyers will have to go to the closing with a minimum of 10% of the purchase price, so why can they not pay half down as good faith payment.
There are no standard, set fees in real estate. Everything is negotiable between the consumer and the brokerage firms, and between the buyers and sellers. The amount of earnest money paid down at the time the offer is written makes a statement about the seriousness of the buyer and about their ability to purchase but the ultimate final decision is made by the parties entering into the agreement.
Should you have specific questions concerning various issues, please let me know and I’ll research the answer for you. I also want to encourage you to subscribe to our “News & Updates” weekly report so you can stay abreast of issues that might affect you when buying or selling real estate. If you haven’t visited my website, please go to www.AlabamaRealEstateInstitute.com and view previous articles.