How Earnest Money Deposits Work With Real-Estate-Owned Homes
Follow these best practices to protect your EMD
Real-estate-owned (REO) properties, also known as bank-owned or foreclosed properties, are properties are owned by a lender because the previous borrower defaulted on their loan. Usually, such properties are offered for sale at a public auction, and when there are no bids at the auction above the minimum price set by the lender, the title reverts to the lender and the property officially becomes an REO property.
When you make an offer on an REO property, you might want to make what is known as an earnest money deposit (EMD), which is a "good faith" deposit that proves your interest in buying the property and may indicate how much you will put down in the form of a down payment. As with other real estate purchases, the deposit is not always required with REOs, but it demonstrates your commitment to go through with the transaction.
But the rules for EMDs can be a little different when it comes to REOs. To complicate matters, there's little conformity among REO lenders as to how each sale is processed. However, you can take certain actions to streamline the process of paying EMDs for real estate transactions involving bank-owned properties.
How EMDs Are Handled In Regular Real Estate Sales
During most regular real estate transactions, a buyer makes the EMD payable to the real estate brokerage or to an escrow or title company. It's typically refundable to the buyer within the inspection period. The EMD is not normally or automatically returned to the buyer until cancellation instructions are signed by both parties. Sometimes, disputes arise that can delay reimbursement.
How to Handle EMDs With REOs
Banks generally don't want to get to the end of the escrow period only to discover that a buyer wasn't serious about buying the foreclosed property. They want to limit the fall-out/cancellation rate by protecting themselves during earlier stages of the contract, which can result in more stringent requirements for how EMDs are treated in a real estate transaction involving an REO property. Follow these tips to successfully navigate EMDs when buying a bank-owned home.
Work With an Agent
The assistance of an experienced real estate agent can be invaluable in REO transactions, which may involve more paperwork and more complex pricing strategies than traditional sales. An agent might even have experience with the particular lender you're dealing with, including that lender's quirks and requirements. The agent can use this know-how to help guide you through the process so that you don't make any costly mistakes.
Use the National Association of Realtors' SFR Directory to find a local realtor who is certified in short sales and foreclosures.
Line Up Financing
You'll likely lose your EMD in a transaction involving an REO if it turns out that you can't get the financing you expect for the property. You might even have to pay a per-diem penalty until such time as you do get approved.
For these reasons, it's generally a good idea to begin the loan qualifying process as early as possible. Try to get pre-approved before you make an offer and write that EMD check for the real estate transaction. The process will require you to undergo a preliminary review of your credit to help a lender determine the amount that you are preapproved to borrow to buy a home.
Sell Your Home First
REO lenders do not want to hear that you first have to sell your home before you can close on a new one. This is a contingency that they most likely will not entertain.
Don't attempt to leave this bit of information out of negotiations, either. If you are found to be misrepresenting the truth to the seller, you could be breaching the terms of your contract. The deal could well fall through, and you could lose your EMD for the real estate transaction.
Time Your Home Inspections
In some cases, the bank may want to make your EMD non-refundable for a real estate transaction involving an REO property. You might need to schedule your home inspections upon verbal acceptance of your offer, in which case you might have less than one day to conduct these inspections.
Line up your inspectors ahead of time and be ready to act the minute your agent tells you the offer will be accepted. This way, you'll have your inspections completed before you deliver that EMD for the real estate transaction, which can save you a lot of grief and worry if you know that you want to proceed with the transaction.
Negotiate an EMD Below the Court Maximum
It's generally easier and faster to take your case to Small Claims Court if the worst happens and you end up in court to get a refund of your EMD. But these courts almost always impose limits on the amount for which you can sue.
You may not receive the entire balance of your EMD even if you win your lawsuit if the deposit exceeds the maximum amount set by the court—unless you file suit in a different court. For this reason, try to settle with the seller on an EMD that is no more than the maximum you can receive for small claims court.
The EMD is usually negotiated between the buyer and the seller and amounts to a small percentage of the purchase price that may vary depending on market conditions, the type of property, and any cash advances to a builder or seller.
Make the EMD Payable to Title or Escrow
If you make your EMD payable to a brokerage, the brokerage may first deposit the money into the brokerage's trust account and then wait for the funds to clear before delivering the funds to the title company. However, the bank might not want to wait for the clearance.
To avoid the delay, the bank will most likely insist that the check be sent directly to the title company. Make the check out to "title or escrow company," the name of which can be filled in later. This will prevent the brokerage from depositing the check.
Have the Funds in Your Account
You could jeopardize the deal if your EMD check bounces. You may only be given a short window of time to deliver the EMD and keep the contract alive. Most likely, you'll have to wire the money as soon as possible, allowing for weekends and holidays, to save the situation. You may also have to be prepared to make other concessions, such as waiving some or all your contract contingencies.
If you don't pay the money within a reasonable timeframe, you could be in default of your contract. The bank might exercise its rights under default provisions of the contract, which could include canceling the deal.
Overnight the EMD If Necessary
If you're concerned that a paper check won't make it to the title or escrow company on time, consider sending the funds overnight for next-day delivery. Escrow companies will sometimes let you use their account to send funds, so ask about an overnight funds transfer service. You may need to find out where the closest overnight carrier is located. When you send the EMD overnight, get a receipt for tracking purposes in case the check doesn't show up on time.
Wire the Funds Directly
Wire transfers allow you to submit the EMD electronically to the title or escrow company without exchanging physical money. They offer convenience and speed; domestic wires can often be processed in as little as one day.
But be careful when following wiring instructions. Crooks can hijack escrow companies, send out their own wiring instructions, and take off with your money. Call the title or escrow company to verify that any instructions you receive are valid.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.
The Urban Institute. "The Impacts of Foreclosures on Families and Communities," Page 12. Accessed Feb. 11, 2020.
Bank of America. "How to Buy a Foreclosed Home." Accessed Feb. 11, 2020.
The North Carolina Real Estate Commission. "Questions and Answers on Earnest Money Deposits," Page 2. Accessed Feb. 11, 2020.
U.S. Department of Housing and Urban Development. "HUD Home Store Frequently Asked Questions (FAQs): Consumers and the General Public," Page 2. Accessed Feb. 11, 2020.
Wells Fargo. "Prequalification Versus Preapproval." Accessed Feb. 11, 2020.
George Real Estate Commission. "Earnest Money Procedures for Licensees." Accessed Feb. 11, 2020.
U.S. Department of Housing and Urban Development. "Section A. Loan Closing Policies," Page 2. Accessed Feb. 11, 2020.
Fannie Mae. "Frequently Asked Questions (FAQs)." Accessed Feb. 11, 2020.
Washington Realtors. "Earnest Money: An Old Dog That Teaches New Tricks." Accessed Feb. 11, 2020.
Wisconsin Court System. "Self-Help Law Center: Small Claims Court." Accessed Feb. 11, 2020.
Texas Young Lawyers Association and the State Bar of Texas. "How to Sue in Justice Court," Page 1. Accessed Feb. 11, 2020.
Texas Realtors. "Earnest Money." Accessed Feb. 11, 2020.
The Rollins Group. "Writing an Offer on a Foreclosed Property." Accessed Feb. 11, 2020.
Ticor Title. "REO-Bank Sale Closing Process." Accessed Feb. 11, 2020.
Texas Realtors. "From the Legal Hotline: What Happens When a Buyer Doesn't Pay the Earnest Money or Option Fee?" Accessed Feb. 11, 2020.
Commonwealth of Virginia. "18VAC135-20-180. Maintenance and Management of Escrow Accounts." Accessed Feb. 11, 2020.
Riverbend Commercial Title Services LP. "Closing and Escrow Services." Accessed Feb. 11, 2020.
Wells Fargo. "The Ins and Outs of Wire Transfers." Accessed Feb. 11, 2020.
National Credit Union Administration. "Wire Transfer Scams Involving Real Estate Transactions Are Increasing." Accessed Feb. 11, 2020.