Should You Offer Non-Refundable Earnest Money? (2024)

Navigating the real estate market involves understanding various financial components; among them, the concept of earnest money. Earnest money signifies a buyer's genuine intent to purchase a property. This deposit is a crucial part of the transaction, contributing towards the down payment. However, what sets transactions apart is the nature of this earnest money — whether it's refundable or non-refundable.

What Is the Earnest Money?

The earnest money — also referred to as an earnest deposit, escrow deposit, or good faith money — is a deposit made to the seller that represents a buyer’s good faith to buy a property.

The earnest money is usually about 1% of the purchase price and goes towards the down payment. For example, if the contract price is $10 million, the earnest deposit will be approximately $100,000.

Generally, the earnest money is due a few days after the execution of the purchase sales agreement (PSA). The exact timeline is outlined in the PSA.

The earnest money can be refundable or non-refundable. If the earnest money is refundable, the buyer will receive their funds back if they use one of the contingencies to back out of the contract. However, if the earnest money is non-refundable, the buyer will not receive their funds back if they use one of the contingencies to cancel the contract.

For non-refundable earnest money, the buyer can stipulate when the money “goes hard” (i.e., becomes non-refundable). The money can go hard on day 1, after a specific task is completed (e.g., due diligence), or after a certain period (e.g., 30 days).

For this blog post, we will be discussing earnest money that goes hard on day 1.

Why Should I Offer Non-Refundable Earnest Money?

When Should I Offer Non-Refundable Earnest Money?

In today’s competitive market, you may need to submit an offer with non-refundable earnest money to be awarded an on-market deal or, in some instances, even to be considered for a deal. However, if you plan on submitting an offer with non-refundable earnest money, your confidence level in the deal needs to be extremely high. To have an extremely high level of confidence, you should spend a lot more time on due diligence before submitting an offer.

During the underwriting and bidding process, spend time understanding the deal, evaluating the market, and creating the business plan. This should entail an extensive market analysis, touring competitive properties, and discussing loan options with potential lenders. However, these tasks should be performed whether you are submitting refundable or non-refundable earnest money.

If you are considering submitting non-refundable earnest money on day 1 after completing the tasks above, take your pre-contract due diligence to the next level. The goal of this next-level due diligence is to be as confident as you can be that you won’t discover any big surprises during the formal due diligence period. To do this, perform the following tasks:

1. Have a contractor (or a person with a strong capital expenditure background) inspect the property to confirm your interior and exterior CapEx budget. Keep in mind that a seller will rarely allow you to do physical inspections of the property with roofers, electricians, plumbers, etc. until you have the deal under contract, but it never hurts to ask. Ideally, you want to do a full, detailed inspection before putting up non-refundable earnest money, but usually, this isn’t possible. Therefore, you should request as much documentation as you can to understand what work has been recently done and what work needs to be done. Specific documentation to request includes work log orders, historical CapEx budgets, and future CapEx budgets.
2. Have detailed conversations with your experienced property management to ensure that they agree with your business plan and your income and expense assumptions.
3. Have more detailed conversations with potential lenders, which should include sharing your pro forma and CapEx budget with them to ensure that you will be able to secure a loan at your projected terms.
4. Engage with a tax and insurance consultant to confirm your insurance and tax expense assumptions.
5. Discuss any items of concern with your attorneys, like zoning, title, or any other legal matters.

During the formal due diligence process after executing the contract, you’ll be able to perform a full, detailed inspection. You will likely find at least a few unforeseen items during this process. Still, your goal should be to make sure the impact of those findings is minimal, especially when you are putting down non-refundable earnest money.

This is accomplished by completing the five tasks listed above. Additionally, to avoid these unforeseen items affecting the projected returns of your deal, create conservative underwriting assumptions that can withstand potential findings. In your capital expenditure assumptions, always include a contingency fund to account for anything you discover. Also, you should leave a cushion in your income and expense assumptions.