Short Sale Non-refundable Earnest Money is a Stupid Idea

I have come to the conclusion that agents who require non-refundable earnest money for their short sales lack the ability or willingness to communicate, or they are just not very bright people. I’m not sure what other conclusion I can draw.

If you’re not familiar with the scenario, let me describe it briefly.

A buyer wants to enter into a contract to purchase a home that is a short sale–the seller owes more on the home than it is worth. As a condition of entering into the contract, the listing agent requires that the buyer place non-refundable earnest money into an escrow account for a period of up to 90 days or until the bank approves the short sale, whichever occurs first. This clause is an additional clause not in the standard Arizona Association of Realtors Residential Resale Purchase Contract.

The theory goes that by holding onto the buyer’s money the seller has created a buyer that is more committed to the transaction.

I find this approach to be uninformed, at best. In most cases, however, the clause provides an excuse so listing agents can avoid communicating with the buyer’s agent. After all, the buyer is on the hook for the next 90 days, right?

Listing agents with the non-refundable earnest money clause are behaving irresponsibly towards their clients and unprofessionally towards their real estate peers. Here’s why.

A buyer may change their mind and move on without penalty

If a buyer chooses to look at other properties, non-refundable earnest money is not going to deter them from doing so. They will just wait out the 90-day time period and cancel the contract either at the expiration of the time period or during the inspection period. If a buyer is not committed to the sale, they will find a way out.

Seller’s agents fail to present valid, qualified offers because it doesn’t fit their system

Imagine a well-qualified buyer wants to buy a home in short sale, but the listing agent won’t even present the offer because it doesn’t include their mandatory earnest money clause. The buyer moves on to something else and the seller’s home forecloses. You don’t think this happens? Think again!

Non-refundable earnest money clauses may cost the SELLER in cash and credit score.

The seller loses precious marketing time by an agent’s requirement for non-refundable earnest money. Let’s say the buyer finds a different property a couple of weeks after the original contract was signed. The buyer simply waits out the 90-day period and cancels. In the meantime, the seller has lost out on a couple of months of marketing time.

Here’s the real shame of it. If the seller is involved in a HAFA or cooperative short sale program, which allows 120 days from price approval to closing, the seller could waste up 90 days of their allotted time on a phantom deal. The listing agent with their non-refundable earnest money clause has now cost the seller up to $3,000 in program incentives, not to mention the additional 30-, 60-, and 90-day late reports on the seller’s credit. How smart is that?

The Buyer is the only one with skin in the game

Through the non-refundable earnest money clause, the seller and seller’s agent are asking the buyer to commit to something to which the seller cannot promise to deliver, namely: Clear title. The seller’s agent wants the buyer to commit financially to the hope that the agent can negotiate a satisfactory agreement between the lender and the seller. The buyer has nothing to do with this arrangement. Despite these facts, the clause places all the risk in the transaction on the buyer. Opportunity costs, potentially rising mortgage rates, and their current living costs, such as rent, are a few of the real buyer costs for waiting. So why is the buyer the only party with anything at risk?

Listing agents fail to communicate

Because they have the buyer “locked in,” listing agents communicate even less than their normal amount, which is typically pretty poor anyway—lack of communication is the number one complaint about REALTORS as cited in NAR surveys. Instead of communicating regularly with buyer’s agents, listing agents expect other parties to trust the listing agent because the listing agent says we should. A recent Gallup Poll regarding the public’s view of the real estate industry shows why this line of thinking is pathetically inappropriate. Trust has to be earned…it’s not given away.

My experience is that a professional real estate agent doesn’t mind being asked questions or providing regular updates. On the other hand, agents who don’t communicate, who don’t like to answer questions tend to be either insecure or incompetent. Strong words, I know, but true nonetheless.

If you are a seller considering a short sale, ask your agent these questions:

• Do you require non-refundable earnest money from the buyer? If so, why?
• If they say, “It keeps the buyer committed,” Ask how?
• If the buyer cancels after 90 days or during the inspection period, what happens to me, the seller?
• How often will you update me and the buyer’s agent?

Be sure you are comfortable with the answers.

The fact is non-refundable earnest money is not going to keep a buyer committed. Too often short sale listing agents lose sight of the fact that the buyer simply wants a home for their family to live in. And if they have found the right home, they are willing to stick it out, whether or not their money is held hostage for 90 days. It’s for this reason that some agents who use the clause have been successful; not because of the clause, but in spite of it. Often times, if a buyer doesn’t know what’s going on with their dream home, they’ll find another one, earnest money or not.

Next topic: A better way: How to responsibly keep a short sale transaction together