Collaboration: Do you have this DNA in your small business? Is it part of your mission statement or mantra?
This is not so much an insight into how a successful real estate transaction comes to fruition as much as it is a testimony of what makes any task, job, objective or goals conclude with a positive outcome. Whether you are in the military and command a small unit of soldiers or, what I commonly describe the role of a Realtor as, “the Conductor
There’s been some “buzz” lately about buyers of new construction condos who purchased pre-construction now wanting out of the deal with a return of their earnest money. Motivations vary: they are no longer able to get financing (“WHAT? I need a down PAYMENT!? Since when??”); their life situations have changed (baby + one bedroom condo = problem); or they simply don’t want to be under water the moment they close (those 2007 prices are not so attractive now…). Regardless of the motivation, though, the developer’s response is almost always the same: “Go pound sand. The earnest money is mine.”
Luckily for buyers, there are various federal and state laws designed to protect consumers that may give the buyer a right of rescission (and thus the right to a full return of the earnest money). For example, several decades ago the federal government enacted the Interstate Land Sales Full Disclosure Act (known to its afficionados as “ILSA”), 15 USC 1701 et seq. specifically to protect buyers of new construction. Generally speaking (its a complex statute), a developer must register the project with the Dept of Housing and Urban Development (HUD) and provide buyers with a comprehensive set of disclosures. However, the developer is exempt from the registration and disclosure requirements if it contractually obligate itself to complete the building within two years.
For reasons unknown, many of the new condo developments in the area decided to structure the purchase and sale agreements to fall within this “two year” exemption. Unfortunately for the developers, it is more difficult than first appears, and most of the contracts at issue at least arguably fail to qualify for the exemption. Thus, the buyers of those condos arguably have the right, under ILSA, to rescind the contract and receive a full return of their earnest money. (My partner Marc Holmes and I recently prevailed in an action against WA Square on this basis, so in at least one case its no longer “arguable” — the developer failed to comply with the statute and the buyer had a right of rescission.)
All of this raises an interesting question: Is it unethical for a new construction buyer to seek a legal basis for getting out of the contract with a full return of the earnest money? Our very own Ardell has argued that, if a buyer simply changes her mind about the purchase, the buyer should lose her earnest money. Other people have voiced a similar opinion. Is that right? Is it morally wrong for a buyer to seek a return of the earnest money? Does the buyer’s motivation in seeking to get out of the contract even matter?
I think the answer to that question can be determined by flipping it around. New condo developers are large entities typically owned by sophisticated multi-millionaires. What if one of those multi-millionairre owners signed a contract that required her to perform her contractual obligations two years later, and when the date for performance arrived she stood to lose substantial money if she performed? What if the owner just changed her mind for some other reason? In either case, I think its safe to say that the owner would not perform her obligations. Rather, she would hire a lawyer to identify each and every possible basis for avoiding her contractual obligations. The lawyer would then approach the other party to the contract and see if the parties could reach a compromise. Rich people got rich for a reason: they don’t intentionally make a bad business decision, and when faced with a situation that will cause them to lose money, they hire an attorney to negotiate their way out of it. They use the law in every way possible way to protect and advance their interests.
Which is, of course, the purpose of the law. It only works when it is applied to a particular situation. ILSA was designed to protect consumers. Developers should comply with this law. If they don’t, the law gives consumers the right to avoid their contractual obligations. There is nothing immoral or unethical in using the law to protect and advance your interests. It’s what is expected of every citizen, and its certainly what is done by every citizen who can afford legal counsel. If you’ve decided to not buy that condo –for whatever reason — then you should determine whether the law is on your side. It’s what every person should do — and what wealthy people do all the time.
This is not legal advice. For legal advice, consult an attorney, not a blog.
In this challenging market, many buyers are discovering that their loan program is no longer available. This is a particular problem with new construction, whether condo or house. The buyer signed a purchase and sale agreement (PSA) several months or even years ago. Back then, in the “good ol’ days,” lenders offered a variety of financing options. Some buyers relied on some of the more “aggressive” options (e.g., an option ARM) in order to qualify for the new home. Today, that financing option is gone, gone, gone, and the buyer can no longer afford to buy the property. What happens then?
Well, the short answer is that the buyer loses the money. In almost every new construction contract, the builder’s addendum will note that the financing contingency, if any, is waived within several weeks of signing the PSA (and months or years before closing). Once the financing contingency is waived, then the risk of a failure of financing rests squarely on the buyer. At that point, if financing fails, it is the buyer’s problem, not the seller’s. Accordingly, if the buyer cannot close as a result, then the buyer will lose the earnest money as the buyer is in default of the PSA.
However, there may be more to the contract than what is seen by the untrained eye. There are a variety of state and even federal laws that apply to the sale of property, and in particular new construction. In many instances, these laws create “loopholes” in the contract that allow the buyer to at least arguably rescind the contract. Thus, depending on the terms of the PSA at issue, these laws can be used to exert negotiating pressure on the seller to at least return some of the earnest money.
Certainly, a buyer should not rely on these laws when signing the PSA originally. Every buyer should be aware of the risks and obligations created by a contract. But sometimes, the buyer’s situation changes (to put “America’s Money Crisis” mildly) and the buyer can no longer perform. Heck, sometimes the buyer may just decide that the purchase is actually a bad idea and not want to complete it. Under those circumstances, the buyer should consult an attorney to determine if there is a mechanism by which the buyer can get some or all of the earnest money back.
It’s not a good time to look at this issue from a hindsight perspective. In this changing market, we need to revisit this topic and talk about how a changing market may influence your decisions and actions in 2008.
In a hot market, the instances of the seller wanting to keep your Earnest Money are fewer. When there’s another buyer standing in line behind you, sellers will often simply say NEXT!
But when buyers making offers are fewer and further between, you will see more sellers wanting to keep that Earnest Money. Time to address this topic from a forward thinking perspective in “better safe than sorry” fashion.
Step 1) The amount of the Earnest Money. When a buyer makes an offer they “put up” Earnest Money. Most buyers will ask, “How much does it NEED to be?” That is really not the way to look at it. Instead ask yourself, “How much am I willing to LOSE?” The purpose of Earnest Money is to get some skin into the game. It’s how you show the seller that you are making the offer “in earnest” and willing to proceed “in good faith” to closing. So DO NOT write that Earnest Money check expecting to get it back if you change your mind! You never should have of course. But it may become more likely in 2008 that sellers will want to keep that money, than they did in the last 4 years or more.
NEW RULE! Don’t write that check for an amount more than you are willing to lose, if you simply change your mind about buying that house. The seller and seller’s agent may counter and ask for more, as they should if it is low. But don’t agree to an increased amount until you again ask yourself, “am I REALLY willing to LOSE this much if I change my mind?”
Step 2) Choosing Your Closing Agent (Escrow) In a Seller’s Market you will often see instructions from the seller’s agent regarding which Title and Escrow Company you are to use when writing an offer. In a hot market you likely won’t want to lose the house arguing over this point. But when you are the only offer in the room on a house that has been on market long enough to feel comfortable that you can bargain in a reasonable manner, choose your escrow company wisely.
Whether it is the Closing Agent or the Real Estate Broker holding your Earnest Money, you want to make sure that they honor unilateral rights to cancel BEFORE you agree to make out that Earnest Money check payable TO them.
So what does that mean? It means sometimes the buyer has a unilateral right to cancel, but the escrow holder has an “internal policy” of requiring the signatures of both parties to release the Earnest Money. Many, if not most, very large escrow companies do not want to take the risk of releasing the Earnest Money to the buyer unless the seller agrees. Sometimes you need the seller to agree and sometimes you don’t. If the escrow holder won’t give you the money because of their internal policy vs. the Purchase and Sale Agreement, you may find yourself talking to a wall instead of getting your money back.
NEW RULE! Pick not only your escrow company, but also speak with your closing agent BEFORE writing that Earnest Money check. Ask your agent writing the contract for your “legal out” addendums in advance. For example, if you are buying a condo, ask for a copy of the blank form you would use to cancel based on the resale certificate. Ask for the form you would use to cancel based on the Form 17 (and do not waive your right to do so in advance). If you have an Inspection Contingency, ask for the form that you would use to cancel based on the Inspection Congingency. Whatever your legal outs, know that most will expire early in the contract. So mark down the drop dead dates of your rights within these legal outs.
Notice whether or not the form requires only your signature to release the Earnest Money, or the signatures of both the buyer and the seller. Let’s assume that these forms only require the signature of the buyer, and the buyer has the unilateral right to cancel. NOW call the proposed Earnest Money holder and verify that they WILL in fact return your Earnest Money with only your signature, in the event you cancel based on one of these uniteral addendums.
If and when you ask someone to agree, they think they have the right to not agree. So if you have say 5 days to cancel, you don’t want the seller to have to agree with your decision in order for you to get your money back. If the escrow company won’t give you your money based solely on the Purchase and Sale Agreement and it’s addendums…well let’s just say you don’t want to be in that position, so know that up front and before you give them your money.
It is not a good time to “go gentle into that good night” and simply not care who the escrow company will be. While you should be prepared to lose your Earnest Money in some cases, one of those cases is not because of an internal escrow company policy.
Do not rely on your Finance Contingency as a means to change your mind. Return of Earnest Money based on the Finance Contingency is rarely, if ever, covered under a unilateral rescission right, as are some other areas of the contract. Often if not always, the seller needs to agree to the release of Earnest Money if you are cancelling based on the Finance Contingency. It’s a good idea to be pretty darned sure you CAN get a mortgage before making an offer. The protection of earnest money often does not go all the way to closing, and so if the loan doesn’t fund at the end on a day that is not covered by the Finance Contingency, or if you didn’t to EVERYTHING in a timely manner…you need to consult an attorney. Sellers will be less likely to say “oh well” in a Buyer’s Market than in a Seller’s Market.
3) When you SHOULD lose your Earnest Money. If you change your mind about buying the house because you have now decided you don’t want it, the seller should keep your Earnest Money. That is the purpose of requiring Earnest Money. You promise to buy the seller’s house, and if you change your mind he gets to keep the Earnest Money. You say, “Here’s $5,000. This is proof that I do ‘sincerely and in earnest’ want to buy your house. If I change my mind, you get to keep that $5,000.” That is what Earnest Money is all about.
Some will say the seller wasn’t damaged, so why should he keep a dime of my money? You have two elections in the contract. “Forfeiture of Earnest Money” or “Seller’s Election of Remedies”. Most times the contract calls for “Forfeiture of Earnest Money”. That means the seller gets your money…period, if you “default”. The seller doesn’t have to prove he was damaged, nor does he even have to be damaged. To talk about damages, you have to have been willing to risk MORE than the Earnest Money at the time you made the offer, and most people don’t do that.
Most people don’t want to pay the seller’s full damages, nor do the want to forfeit their earnest money. So really they want an election that says, “None of the above! I just want my money back!” Doesn’t work that way.
You will see more and more sellers wanting to keep that money than in the past. Why? Because another buyer is not as easy to come by as it was in the last few years. Before you go to an attorney to get your Earnest Money back, maybe you should first look at yourself in the mirror and ask yourself if the seller should get to keep it. If you just changed your mind, “without legal excuse”, remember that is why you put that money up in the first place.
As with any blog, this is not legal advice. If you want legal advice, consult an attorney in your area.
Escala. 1521 second avenue. Olive 8. Just a few of the many luxury, high-end condominiums going up in the Emerald City. Needless to say, when its “designed exclusively for the confident few,” you can be sure there will be a stiff price of admission. Indeed, these developers not only charge a high price, they also typically require a substantial earnest money deposit, usually 5% of the purchase price. On a million dollar condo, thats $50k. You’ll pony up this sum months, and even years, before the condo is complete and ready to close.
So what happens if you change your mind between the time you signed the presale contract and when the closing date approaches? What happens if the market goes in the tank and you want out of the deal? Or you foolishly went long on a can’t-miss investment opportunity, and now you’re not so sure you’re one of the “confident few”? Can you get your money back?
The short answer is “no.” Developers typically structure their contracts so that the earnest money will be forfeited if the buyer does not close. Buyers backing out of the deal is every developer’s nightmare — they need to sell the units and move on to the next project. Accordingly, developers do everything they can to “lock in” a buyer.
That said, there are typically a few avenues of attack if you really want out of the deal. To determine whether you are really serious about getting out of the deal (versus typical “buyer’s remorse”), ask yourself: “What would be worse, buying this condo or losing my earnest money?” If buying the condo is the worst possible outcome, worse even than losing your earnest money, then you’re ready to head for the exits.
One fertile area of inquiry is the Public Offering Statement (POS). By law, the seller of a new condo must provide the buyer with POS, which contains a variety of information about the condo development. Upon receipt, the buyer has a 7 day right of rescission and can therefore rescind the contract within that period with a full return of the earnest money. The seller must also provide the buyer with “all material amendments” to the POS, and upon receipt the buyer has another right of rescission if the “purchaser would have that right under generally applicable legal principles.”
Therein lies the rub, of course. These “generally applicable legal principles” are not spelled out in the statute, so it is a bit of an open question as to the extent of a change in the POS (between when provided to the buyer initially and when finalized) that gives rise to another right of rescission. Regardless, however, it creates an arguable point with attendant risk to all parties if they are unable to voluntarily resolve the dispute. Since every POS changes between the initial, presale version and the final version, a buyer can usually use these changes to negotiate at least a partial return of the earnest money.
There are other “arguable points” as well, all of which can lead to a negotiated resolution and a return of at least some of the money. Many developers are apparently unaware of the Interstate Land Sales Disclosure Act, a federal law that applies to large-scale developments. This statute has several requirements, including a disclosure requirement similar to the POS. If the seller fails to abide by the requirements of this federal statute, the buyer may have a right of rescission. There are many exceptions to this statue, but as long as there is some doubt, it will assist the buyer in negotiating a resolution.
In the final analysis, it is probably worth it to hire an attorney if there is a substantial amount of earnest money at issue (almost guaranteed if you’re talking about a luxury condo). The attorney will be able to identify those legal issues that can be used to negotiate a resolution. In doing so, you will probably get some of your earnest money back, and that total will probably be more than what you spent on attorney’s fees.
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For those of you who grew up in the 70’s, if you were like me and missed an episode of the Rockford Files, you were really bummed out. Missing the Rockford Files was almost as bad as my parents making me late for my soccer games. Not a good thing. Tivo, where were you?
Jim Rockford (James Garner), what a guy. He always seemed to get into a pickle and get out of it. That Pointiac Firebird of his; all my friends wanted one, even if it meant riding my dirt bike to the store and buying a $2.50 model of it and putting it on my dresser. That was good enough for me. Those humorous one liners with “Angel,” brings back lots of great memories. The humor reminds me of some of the things we have come across in the world of escrow. In escrow, if you can’t find any humor in the business, it will eat you up.
Rather than send out mundane APB’s to our entire client base about issues that come up or tips based upon transactions that go haywire, we think that adding humor into the fold has more impact and can also be helpful to our Realtor customers in providing better service and foster smoother closings for their clients.
For example, escrow companies are extremely busy at months end and the phones ring constantly. It’s hard to get work done when you receive phone calls from nearly every party, sometimes two or three times in a day, asking, “is it closed yet?” So, to help reduce stress at month end, we started a “counting” system where we tally the transaction with the most phone calls asking, “is it closed yet?”
We made the question, “Is it closed yet?” into a funny YouTube video parody skit, starring our kids who play the Realtor, the buyer, the seller and loan officer. The movie series is called “The Escrow Files.” This Fall our series will be both print and video.
Since the month ended yesterday, the transaction with the most “is it closed yet” calls was nine! For perspective, if our small office closed 30 purchase transactions this August, you get a good picture of all the people calling: buyers, sellers, agents, loan officers, funding depts, etc….on just one deal…now multiply by 30. Maybe we should get another number from Verizon dedicated as our “Is it closed yet?” hotline!
To tickle your funny bone here’s a sample from this year’s, The Escrow Files:
- Written on an “Addendum” during 2nd quarter 2006: “Buyer to walk through house prior to closing.” Didn’t they do that already, like many times?
- Lowest earnest money amount winner ytd: $200 cash. Wow.
- “Should I stick around for you to cut my commission check?” –agent with clients who just signed their loan docs and the deal won’t close for another week.
Stay tuned for more and have a great three day weekend! We are looking forward to the day off!
Tim & Lynlee
[photopress:check.jpg,thumb,alignright]The times they are a changing.
Personally, I don’t see any reason why anyone except the closing agent, should view my buyer client’s personal check. A “qualified reperesentative” from the escrow company, picks up the check and gives me a receipt for it. When they deposit the check at escrow, I get a second receipt showing the funds were deposited.
When the seller’s agent wants “a copy of the Earnest Money check”, I give them a copy of the “Deposit Receipt” instead. In my mind this is proof enough that the Earnest Money is on deposit where it needs to be, with the closing agent. I received a fax last week from a seller’s agent saying “My company needs the buyer’s account number from the bottom of the Earnest Money check”. Isn’t this an outdated policy? Why do they need my client’s personal checking account number? And why do I care about the internal policies of a company I am not associated with?
When I represent the buyer, I don’t really care what the “policy” of the seller’s agent’s company is. When I represent the seller, I don’t really care what the “policy” of the buyer agent’s company is. If a “deposit receipt” that contains NO personal information of the buyer’s account is good enough for the DOL, and it is, then it should be good enough for all of the real estate companies.
Protecting my client’s information against identity theft and fraud, is my only concern, once complying with the State’s requirements. Multiple copies of the personal check of the buyer floating around in everyone’s files, is a policy to be changed…not complied with for the sake of making someone’s little checklist, designed in the dark ages, complete.
While the purpose of the Finance Contingency is to protect the buyer in the event they are not able to obtain a mortgage, more and more the buyer is not covered all the way to the day of closing.
In a perfect world, the buyer submits an offer with a Finance Contingency that runs through the day of closing. If the buyer’s loan is rejected, the sale becomes null and void and the Earnest Money is returned to the buyer. The seller puts his property back on the market and finds a different buyer.
Finance Contingency addendums are two pages long and much more complicated than the simple explanation above, and much more dangerous to the buyer than they often expect. I have not met a buyer in 15 years who did not expect to get their Earnest Money returned if their loan is not approved. I also have not had a buyer client in 15 years whose loan was not approved 🙂
It is becoming common practice in the last few years for the seller to counter the offer by shortening the timeframe on the Finance Contingency. Often this is deemed a minor date change, when in fact it is a major change for the buyer. I have even seen buyer’s agents write offers with a 30 day escrow and a 15 day finance contingency because that is “common practice” :0
If you have a 30 day escrow and a finance contingency that expires in 15 days, you are not likely covered if the loan is rejected on the 23rd day. You are also not covered if you did not apply for your loan on time or if you did not submit the documents to the lender in a timely manner.
VERY IMPORTANT, you are also not covered if you do not have enough cash to close.
I am hoping the attorneys here will have something to add, or will have something on their blog explaining this further. In the meantime, suffice it to say that just because you have a Finance Contingency, that does not mean that you will automatically get your Earnest Money returned, if you can not close due to financing issues.
Some of the most Frequently Asked Questions in a Real Estate Transaction involve the Earnest Money Deposit. The Earnest Money usually follows with the transaction from day one all the way through to the last day, as in “follow the money”.
The buyer usually writes a check for the Earnest Money deposit at the same time that they sign the offer and they hand it to their Buyer Agent. The check can be made payable directly to the Escrow Company they chose in the contract, or to the Buyer Agent’s Company if they have an in house Trust/Escrow Account. More and more these checks are made payable to the closing agent.
When the seller accepts the buyer’s offer, the check gets deposited. Let’s assume the check was made payable to escrow and went directly to the escrow company for deposit.
At close of escrow this money comes back to the buyer as a credit against his costs or downpayment. If it is a zero down loan and the seller is paying the closing costs in full, this $1,000.00 can be returned to the buyer at close of escrow.
If you know you really want the house when you make the offer, and you have no problems at all throughout the transaction, the Earnest Money just slides like butter from your hand and back into your hand. Whether it actually goes into your hand at the end or is paid against your costs varies from transaction to transaction. But it still simply comes back to you like a boomarang.
The only time you should be worried about handing over an Earnest Money check, is if you are not sure you want the house at the time you make the offer 🙂