ten-dollar-billMultiple offers are a joy to home sellers and a nightmare for home buyers.  There are many disclosures warning of the dangers of overbidding and giving away too many rights in the purchase agreement, and rightly so.  You certainly never want to give up that which will make you overly vulnerable (such as no contingencies for financing or property inspection).   At the same time, though, to actually be the winning bidder, your offer must be better than everyone else’s.  Financing terms can really “make or break” your offer.  Today we’ll discuss a couple of those financing terms: the initial deposit  & the increase of deposit (and related issues of liquidated damages and default).

What are financing terms?   They are all the details of how exactly you will pay for the home and get money into escrow.  For example:

  • good faith deposit (initial deposit)
  • increase of deposit (if needed)
  • loan type (conventional, FHA, VA, seller carry?)
  • loan costs (will you pay or are you asking the seller to help pay?)
  • loan terms: are they realistic?
  • is there a pre-approval letter or a pre-qualification letter?
  • what is the total down payment amount? (and % of purchase price)
  • will you provide the “proof of funds” to the seller?
  • will you submit a copy of the check with your offer?

The initial deposit or good faith deposit is the amount of money that you’re “putting down” with your offer.  If your contract to buy the home is accepted, that check will be cashed within a day or two, so make sure that you write one that will not bounce!  In the San Jose area, most real estate agents write the offer such that there are three business days to get that money into the title company (which handles escrow services in northern California most of the time), but make sure you know how many days it is because it can be variable.  It is written right in the contract, so read & understand it.

(Please note that except for the initial deposit, the rest of the contract will reference days, not business days, if your agent is using either the CAR or PRDS purchase agreement form, both of which are standard in Santa Clara County and San Jose generally.)

Smart real estate agents will usually look for 3% deposit when a home sells, preferably in the initial deposit, but possibly part in that first check and the balance in an “increase of deposit”, which normally would happen when all contingencies are removed.  If you are competing against other homebuyers and your deposit is less than 3%, your position is weakened relative to theirs.

Why does the 3% target matter so much?  The reason is that it’s connected to the liquidated damages clause.  The liquidated damages clause is something buyer and seller would need to agree to for it to be enforceable, so in our PRDS or CAR purchase agreement forms there’s a place for buyers and sellers to initial it if desired (and in my experience, everyone does initial for it).  The deposit (and possibly increase of deposit)  is the potential penalty if the buyer defaults on the purchase.  (I’ll speak of defaults below.)

Sellers, then, want to see that you’re serious enough to put the maximum amount of liquidated damages money into escrow.  Some real estate trainers nudge Realtors and other real estate salespeople to put even more down as a “show of strength”.  Earlier this week, I sold a Willow Glen home in which the buyers put down more than 3% to make a point.  It was multiple offers and that was one way of showing their seriousness in making an offer on the house.

I do not think it actually makes any difference whether you put down 3%, 4%, 5% or more because the contract states that the magic number is 3%, nothing more.  So I do not suggest to my clients that they tie up their money that way when writing a competitive purchase agreement, but I do suggest that if they are able to do so, they put the full 3% down upfront. Sometimes that is just not possible, and when that’s the case, I suggest making sure that between the initial deposit and the good faith deposit, there’s 3%.

Sometimes buyers just cannot come up with the 3%. Then what?  Tell the listing agent – rather, have your agent tell the listing agent – what’s going on.  Believe me, if there are a bunch of offers on the property, most will have the 3% so you do not want to pretend like yours is on par.  Whatever the reason, have your agent explain so that the sellers of the property know that at least you know and understand that shortcoming of the offer.

When do you, as a buyer, risk losing that deposit money? I have never had a buyer lose a deposit, because most buyers would never think of defaulting – when they write an offer to purchase a piece of real estate, they do their due diligence and if they need to get out of the contract, do so during the contingency period, not after.  Only if you default do you risk losing the deposit money.

A default is non-performance.  This is not the same thing as getting out of the contract due to a contingency.

If your loan does not go through and it’s not your fault (failure to submit paperwork, for instance, would be your fault), you may be able to get out of the contract due to your loan contingency.   If you have used the CAR contract, you may also have an appraisal contingency (not mentioned in the PRDS form), so if the home does not appraise to purchase price, you may be able to be released from the contract without penalty.  (I write “may” because there are many nuances involved.)

If you change your mind about buying the condo, townhouse or house during the escrow period because you have discovered something new that changes your estimation of the home’s value or desirability during your contingency period, you usually can get out of the contract and have your deposit returned (less any unpaid bills you may have created during the escrow, such as inspection fees or appraisal costs) because you should have a property condition contingency.

It really depends on the way in which the agreement is drafted, but if you have a normal contingency period, you can usually get out of the agreement and recover your deposit for a variety of reasons.  That is one of the reasons that agents usually tell their clients to NOT write in zero days for contingencies. It’s far too dangerous – keep your right to investigate the property and obtain a loan.  Smart sellers want you to keep your rights too, because they know that if you don’t have enough time and feel trapped, they could later be facing some sort of lawsuit. Just don’t do that – give yourself at least some time.

An example of a potential buyer default would be deciding to not close escrow after all contingencies were removed.  I say “potential” because there may be some exceptions to the rule.  If the seller give you a completed Transfer Disclosure Statement (TDS) after the removal of your contingencies, rather than before, you have an automatic 3 day “right of recession” and you may read something in the TDS and potentially get out of the contract that way.  Or if you have used the PRDS contract and there’s a “risk of loss” issue, such as a fire at the property that significantly damages the home – in that case, even if your contingencies are removed, you may still be able to cancel and get your deposit returned.  Generally, though, once your contingencies are removed (which you do in writing), if you want to back out of the purchase agreement, that will probably be considered a default and your deposit will then be at risk.

One more note about damages: the seller does not automatically get the liquidated damages money if you default – there must actually be damage.  So if you’re in an “appreciating market” and the seller’s home is now worth more and the seller will actually be better off because you defaulted (and the home sells for more), it may be that there’s no actual harm done. That makes it hard to collect on liquidated damages.  In a declining market, though, it is a much more likely scenario.

Work with a good, fulltime, experienced Realtor and he or she will explain these clauses to you in depth and help you to write the best terms possible to make your offer competitive against multiples while still protecting you so that you are not overly exposed.  It is a bit of a balancing act: offer weak terms (and price) and you may not get the home.  Make your offer’s terms too strong and you put yourself at risk.  Often, you can make your terms strong while still protecting yourself, though – and that makes for an ideal, winning combination when you’re up against multiples.