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February 21, 2015 | No comments yetTags: buying, contracts, earnest money, earnest money promissory note, financing, selling
Earnest money promissory notes are kind of a unique little animal in the real estate world, at least in the residential sector. They are rarely used in Colorado, but they are not without their place in the right scenario. Used carefully, they can be really helpful in contract negotiations.
If you need a refresher on what earnest money actually is, I’ve got a whole page of information for you. Go ahead and jump over there to get back up to speed. I’ll wait.
Earnest money rarely in jeopardy
Earnest money is one of those things that people — buyers and sellers both, but mostly buyers — freak out about in a real estate transaction. I get that there is a great deal of concern about losing your earnest money when you enter into a contract to buy real estate.
Really, though, you shouldn’t be that concerned. If the contract falls apart through no fault of your own (that part is really important), then your earnest money should not be in jeopardy. As long as you, the buyer, are acting in earnest, everything should be fine.
Earnest money promissory notes
Some buyers, however, in order to protect themselves against the perceived strength of the seller, refuse to back up their earnestness with cash. Instead, they offer a different kind of asset in the form of an earnest money promissory note — an IOU, if you will — knowing that the seller will be hard pressed to collect if the whole thing goes south.
This tactic rarely works, however.
The seller — especially in a strong seller’s market like the one we are currently experiencing — will very likely not accept any offer that includes an earnest money promissory note instead of cash earnest money. It’s just too unusual. In a multiple-offer scenario, sellers are just looking for reasons to reject offers to make their decision-making process easier. Something out of the ordinary, like an earnest money promissory note, certainly raises a red flag. From the seller’s perspective, it seems as if the buyer is NOT, in fact, earnest. Just the inclusion of an earnest money promissory note with your offer might be enough to get that offer rejected outright.
It’s not always cut-and-dried
Never say never, however. Sometimes, an earnest money promissory note is exactly what a particular situation needs. Say, for example, that you’ve just started looking for a new home. You know the seller’s market is a strong one, and you figure you’ll be looking for a while. The money you will be using for your down payment is currently locked up in some certificates of deposit. The penalty for early withdrawal is pretty hefty, so you want to just leave it alone until it matures. That, you figure, will be before you need to close on your new home.
Then, of course, right away you find the perfect home. In a seller’s market like ours, you can’t wait, so you put an offer in right away. So do several other parties. The seller really likes your offer, but others have put up more earnest money than you did. The seller wants to know if you can you increase your earnest money.
Ooooh, you think, the first CD doesn’t come due for a week. It’ll cost dearly to cash it in, and could cost you the house if you don’t. What do you do?
That’s about as perfect a scenario for an earnest money promissory note as you’re going to get. You must, however, be really aware of a few things.
- The seller is not likely to be very keen on getting an earnest money promissory note instead of earnest money cash. If you’re going to try this, make sure everyone is aware of the situation, and on board before you do it. You’ll probably need to provide some kind of proof that you do, really, have the money available in a CD, and it’s about to mature. Think bank statements, for example.
- When you write an earnest money promissory note, make sure you make it come due as soon as possible after the “real” earnest money will become available.
- When the earnest money promissory note comes due, pay it off promptly.
- MAKE SURE YOUR LENDER KNOWS WHAT IS GOING ON! I cannot stress that enough. The lender needs to know where every bit of the financing is coming from. You cannot just say, “my money, my problem.” It doesn’t work that way. More than anyone, the lender holds the keys to the castle. If the lender doesn’t like how all the pieces fit together, you’ll never get the keys. Trust me on this.
Of course, a not-quite-mature CD is not the only scenario where you might not have the cash available to make the kind of earnest money deposit you need to make. Your money could be tied up for any number of reasons. Maybe it’s in an off-shore account, or you’re selling some of your stuff on e-Bay, but PayPal hasn’t released your funds yet. Maybe everything is tied up in the sale of your old house, and that closing has been delayed for some reason or another. It happens.
The important thing is, an earnest money promissory note could be a useful tool in your real estate negotiations. Don’t forget it’s there, but if you’re going to use it, don’t just spring it on anyone. It’s such an unusual beast that people are afraid of it. Without a compelling reason, sellers seldom see a need to overcome their fear.
Have you ever used an earnest money promissory note? Would you accept one? Tell me about it in the comments below.
Until next time, remember, when you’re searching for real estate services in Highlands Ranch and the south metro Denver, Colorado area, I’m ready to help you however I can, and I’m never too busy for you or your referrals. You need only reach out to me.
Randall Brennan, REALTOR
EQUITY COLORADO REAL ESTATE
Randall is a real estate broker and REALTOR plying his trade in the southern part of the Denver, Colorado metropolitan area, including the cities and communities of Highlands Ranch, Littleton, Englewood, and Centennial. He finds interest in just about anything, but especially in history, photography, endurance sports, and permaculture gardening.
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