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Tag Archives: business of real estate

Wayback Wednesday… How Much Earnest Money?

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Two years ago I thought it would be good to post a little about Earnest Money… how much is enough, and what is it for?  It is actually a pretty common question, especially among first time home buyers.  But, even those that have been through the process a few times still often have a few questions, both buyers and sellers.

What is Earnest Money…

Basically, it is like a little insurance policy that the buyers are serious.  Buyers offer Earnest Money (EM) in order to show that they are serious (earnest) about the offer they are submitting.  In offering the EM, they are saying “we intend to follow through on this offer”.  The EM is credited to the buyer at the closing table, either toward their down payment or their closing costs.  If the sale doesn’t happen, and the cause of the failure is the buyer, the EM usually serves as “Liquidated Damages“.  In effect, it compensates the seller for the extra costs of removing their property from the market.

How much Earnest Money is enough?

 

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A good rule of thumb is 1% of the purchase price.  In most cases, the buyer will need to have a minimum of 3.5% at the closing table, so having less than a third of that wrapped up with the contract shouldn’t seem onerous.  In some institutional sales (generally foreclosures), the seller requires Cash Buyers to put up 10%.  Their thought is that if there is enough money in the bank to buy the property, coming up with a tenth of that shouldn’t be a problem.

 

Sellers always want to see more EM…  Buyers usually want to use less.

What happens to the Earnest Money?

If the sale closes, the EM is credited to the buyer at the closing table.  It goes toward closing costs, down payment or as a credit against the price (in any winning combination).  In that regard, more EM isn’t a hardship for buyers… up to a point.

If the sale doesn’t close, then there are more possibilities… all are ruled by the purchase contract.

  • If the property has an inspection issue, generally the EM is refunded to the buyer.
  • If the buyer is unable to qualify for financing, the contract will state the time-lines that will determine if the buyer or seller gets the EM.
  • If the buyer backs from the sale outside of the contract’s time-lines, the seller generally gets the EM.
  • If the seller misrepresents the property, even after the Due Diligence period, the buyer may have a claim on the EM.

A couple of final thoughts…

There ARE costs for a seller in removing a property from the market.  Seldom are they direct, though.  But, by removing a property from the market for a sale that ultimately fails, the seller may lose out on a buyer that WOULD be able to fulfill the purchase contract.  And, in many cases, the property may be stigmatized from going under contract and then coming back on the market… other buyers may assume that the reason the property was off the market was that there were inspection issues rather than financing issues on the part of the buyer.

As a bottom line, Earnest Money is an important, but often overlooked part of the initial offer, negotiations and the contract to purchase a home.

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The Gwinnett County Market is a Little Weird Right Now…

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I have been pulling Gwinnett County Real Estate Market Data, and I’m not done with it yet.  But, I have been seeing a few things.

  • Listings are down markedly from where they would normally be.  This can be either a positive or negative, depending on your outlook.
    • On the Plus Side, fewer listings means that Absorption Rates are better.  There is less inventory to get sold… it tilts the table back toward sellers.  It has been largely tilted toward buyers for quite a while.
    • On the Minus Side, it shows that there is pessimism in the market on the side of sellers.  They aren’t confident about the market.  That lack of confidence has carried over to buyers… sales are also slowing.
  • Sales are down… like I just mentioned.  Even though Absorption Rates make the market look better… the sales just aren’t there.
  • Results are mixed.  There are a few cities that are doing well… and there are a few price segments that are doing quite well.  Others are VERY weak.
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Another Way to Increase Existing Home Values…

Abolish the IRS

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I am a fan of the FairTax.  I don’t think that income taxes are right… at ANY level.  When taxing production, the government is laying claim to a portion of the life of the taxpayer… and I don’t feel that ANYONE has the right to lay claim to a portion of the life of another.  By taxing consumption, there is no direct taxation on the production of a person, but rather on what they take up.

But that is another post…

But, as I was thinking the other day, I had a thought…  Implementation of the FairTax might be a natural solution for homeowners that are underwater on their homes. The FairTax would eliminate all payroll and income taxes, replacing them with a single retail level sales tax.  That tax would make up 23% of the cost of new retail goods and services.  In effect, new construction homes would be subject to the tax, but existing homes would not.

While the savings for builders (and their subcontractors) would likely drive down new construction prices by some portion, there would likely be a period at the beginning where existing home prices would bump up.  In effect, sellers would be able to raise their prices since the competition from new homes would be limited.  In the long run, prices for new homes would return to pre-FairTax levels (or slightly higher), but there would be a window allowing some sellers to get out from under their homes.

There is also the matter of economic growth.  There are a fair number of studies that point to increasing economic growth (spelled J-O-B-S) going hand in hand with the FairTax.  Increasing employment would also increase housing demand… increasing prices.  Again, that would help those that are just hanging on by letting them get out without resorting to short sales and foreclosures.

 

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A Seat at the Table…

Freddie Mac

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Millions of American families are facing foreclosure.  Millions more have already been through the process… and there are millions that don’t know it yet, but they will be staring at foreclosure proceedings in the future.  It is an epidemic, one that is difficult to escape.  Not impossible… but difficult.

Foreclosures are accelerating for a couple of reasons… but one of them is momentum.  As a neighborhood faces foreclosures, the values of the non-foreclosed homes dwindles.  Foreclosures generally bring lower prices, which pushes down the prices of non-foreclosed homes… which pushes down the prices of the foreclosures.  It is a self-perpetuating cycle.  Buyers are afraid to jump in because they see prices still moving down.  Sellers get desperate to get out because they see their equity (if they have any) drying up.  The cycle continues.  Some of the people that needed to move couldn’t hack the values anymore, and they let their home slide into foreclosure.

Those that are marginal or that trying to be proactive call their banks.  They talk with them about short sales or loan modification.  For the vast majority seeking a loan modification (we are talking 98%+ here), they might as well talk to a brick wall.  Short sales are slightly more common, assuming the seller only has one mortgage.

Banks simply aren’t really open to talking with the homeowners about their situation.  And there are a variety of reasons.  Some of them they are willing to say (in an unguarded moment, perhaps).  Other reasons the people in the Loss Mitigation department might not even realize… if they do, they aren’t talking.

  • The sign in the lobby of AIG's headquarters at...

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    The borrower doesn’t have enough income anymore to support the modified loan (in their opinion…)

  • If they grant a principal reduction to one borrower, they will be flooded with others expecting the same thing.
  • The “other bank” won’t accept an amount that is inside of their guidelines.
  • There just isn’t enough staff/resources to handle the load.

And the big one that nobody seems to talk about…

  • The banks insurance on the loan will cover them in a default, limiting the amount of loss they will suffer.  However, if they modify or allow a short sale, their insurance won’t kick in.  That increases their loss.

This is the one that really needs to be worked on.  The insurance company… the people that REALLY need to be involved in loss mitigation, don’t have a seat at the table.  And the big losses are at the loan insurance level.  Whether it is a private insurer like AIG (remember their bailout?), a government sponsored entity  like Freddie Mac or Fannie Mae or a public loan guarantor HUD, they don’t have the chance to be actively involved in the process until it is too late.

To Fix it…

The first thing that would need to happen is for the entity that insures of guarantees the loan to have an active role in the decision about modification or foreclosure.  Right now, in the case of a short sale, it is up to the “investors”, those that actually own the loan (often that is NOT the bank).

When a homeowner inquires about a loan modification, the bank should do their best to determine two things… they should look at the value of the property and the homeowner’s ability to pay.  What they should be looking for is to find at what level the homeowner would likely be able to pay.  At that point, the insurance company (or loan guarantor) should take over if the numbers look like they would be bearing the loss.

 

graph shows U.S. foreclosure trends (quantity ...

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Example:

 

  1. Bob the homeowner loses his job and ends up working for less money.  He can no longer really afford his home, but doesn’t want to walk away.  He paid $300,000 for the house and owes $285,000.
  2. Bob contacts his bank.  The bank determines that the house would likely sell in a foreclosure sale for $210,000.  Bob would be able to qualify for a loan of $220,000.  The banks insurance kicks in at $240,000.
  3. At this point, the insurer would review the file.  If the bank takes the house, they would have to pay the bank whatever loss they suffered under $240,000.
  4. Rather than the bank going through with foreclosure, the insurance company agrees to pay $30,000 if they re-write Bob’s loan to $215,000.

Bob ends up owing a little more than the house might fetch in a foreclosure sale.  The bank doesn’t incur the costs of foreclosing and having to get the property ready for sale.  The insurance company takes a hit, but it might be a smaller hit than they would have taken had the house been foreclosed.  And there is less risk for everyone involved.

 

 

Free Money Collection in Cash

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Of course, the example above is completely fictitious.  The numbers are pulled out of thin air…  And honestly, there are a LOT of people that would not be helped in such a situation.  The goal, however, isn’t to save every homeowner in the country that is upside-down.  The goal is to minimize losses to consumers, the banks, insurance companies, GSEs and the government, while helping people that still have some capacity to participate.

 

 

People without income or expenses too high to make a reasonable payment are not going to be helped.  People that take advantage of the system once and are trying to get a third chance would likely not be helped (I would call a program like this a good second chance).

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Can the Market Decide?

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It has been almost a year since the last of the real estate targeted stimulus funds ended.  In fact, it was April 30th last year that contracts had to be written… with a June closing.

Interest rates were a touch higher than now… and sales were mixed compared to this year.  They were certainly up from the year before.

But there are some other VERY important facts to also consider:

  • Values in most of the country, including Gwinnett County, GA, are down from last year…  +$8000 tax credit…  -$15000 in value.
  • The government (taxpayers) borrowed about $17 billion for the rebates…
  • Much of the money went to people that would have bought homes anyway…
  • A good bit of the money went to people that weren’t actually eligible…

Maybe we should have just let the market work it out.  Maybe.

Here we are a year after the credits started to go away, and the market is showing signs of recovery… but the market tanked for a while immediately after the credits expired.  It would be VERY easy to argue that the reason the market is starting to turn is that prices have eroded further, not because of any lasting stimulation effect of the tax credit.

$17 billion here, $17 billion there… pretty soon you are talking about real money…

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