Earnest money related to New construction?

Question

The builder is requiring us to put down 10% of the pucrhase price as earnest money, but directly to him an not in an escrow account.

Or asking for 10% (allowing escrow) plus 5% promissory note

Is this common?

Answer 1

What ever money that you would give to him becomes a personal loan.  Try collection this money back if he does not complete or start on the house.  So many builders are filing bankruptcy .

Answer 2

Earnest money is usually $500, give or take, and deposited into an escrow account.

You need to back away and look for a different house in a different area.

Answer 3

This depends on the laws of the state.  Check with the Attorney General.  In my state, Maryland, you can only take 5% down without an escrow account being set up.  You also have to be a registered home builder with the state to enter a contract with a buyer.

Beware of so-called builders.

Jeff

http://www.yourwayoutcoach.com

Answer 4

No, this is NOT common.  Your earnest money IS your escrow money and you should get credit for it on your loan paperwork.  

I would do a background check on this builder before you deal with him.  It sounds like he is going to pocket the money and not credit you for it.  Run, don't walk to another builder who is certified by the state and follows the law.

Answer 5

Each state has it own regulations, but this does not sound above board.  Any earnest money needs to be placed in an escrow account (and you can ask for that to be interest bearing).  Think twice before writing this check.

Answer 6

Earnest money is required upon signing of a contract to purchase real property.  This money goes to the Lender, not the Builder or Contractor.  These funds are to open escrow on the property chosen.

Answer 7

I'm a Florida real estate attorney.  Everything except the builder's ability to cancel the contract is normal here.  See a local real estate attorney at the link below.

Answer 8

The second option, with 5% promisory note being a fall back position for the lender, would be fairly in line with common practice, assuming the 5%  plus the 10% becomes part of your down payment on successful inspection.

If the builder should go bankrupt, your escrow money, 10%, would come back to you but not the 5%.

Option 1, 10% not in escrow, would be like the second except that you put at risk 10% should the  builder fail.

Because the builder is into this deal for the  whole cost of the house, it is not entirely unreasonable for them to ask you to carry 5% of the risk.

But if they ask you to assume 5% risk, you should have an option to take over the whole project, assume all debts outstanding on the property, and complete the project on your own financing. You should not be left with no way to decide to complete your project.

Answer 9

I wouldn't do it, is standard practice to put down earnest money, 10% seems to be alot but not is not the real issue.  In my state earnest money has to go into an escrow account.  You also won't be able to go into escrow until your home is ready to occupy.

My advice is dependant on the market.  Your future home may be "worth" $100,000 to day, $90,000 upon completion.  I they banks continue theway they are going you won't be able to get a loan $100,000 loan for you now $90,000 home.  They want as much cash as they can to help of set this possible problem.  

I think he is asking fot a 10k deposit so you don't go looking somewhere else.  A few years back (when new homes where selling like hot cakes) most builder would ask for much less because they do prices would go up and you would hang in through the new constructions AND ALL ITS DELAYS.  They are now worried you won't and want that 10k to keep you.

My advice would be find an existing home, in this market (again assumuing your market is in the condition that most are) buy an existing home.  You can get MUCH MUCH more for the money

Answer 10

WAIT!  You need to know how your state views "earnest money".  Second, it's not uncommon for you to make the check out to the builders company, and if his name is his company name that is fine, but have you done your homework on his financial standing within the community? Have you checked his suppliers to make sure his bills are paid?  And does he have a valid license to be practicing business in your state?  Also know this, in some places earnest money is refundable under certain circumstances.  While a "deposit" may not be. So know which terms the builder is using.  Also know this, that a builder does have expences up front; plans drawings, permits etc. that can cost a great deal.  

I want you to do your homework on this builder before you give him any money. All it takes are phone calls. While talking with past clients is good, knowing his financial status is better for you.

Answer 11

He wants 10%? He must be smoking some good S H I T. For earnest money, I have never seen anyone put more than 5% down. I would also definately make sure it goes to a reputble title company. As for the previous answser, NO they do not use the earnest money for materials. Thats against the law. Thats what a construction loan is for

Answer 12

This question should be referred to your attorney. There is a risk to you in doing this, as the builder could go out of business, leaving you with nothing.

You do have an attorney for this don't you? How big an amount is this for? Ever done this before? $100/hour may be very cheap to keep you solvent.

Regards,

Dan

Answer 13

What?  No, this is not common, if you are putting a deposit down, it should go into an escrow account, not some private builder's account where he can refuse to peel you a check if this transaction goes south.

Where is your Realtor in this mess?

Answer 14

Yes.

Answer 15

beggars can't be choosers.  If he wants your business, it will have to be under your terms.  put the money in escrow.  this will show you are serious about it, but protects you at the same time.

Answer 16

I don't know if that's customary in that area but it would concern me if I were the buyer.  The fact that it's not being held in escrow says to me the builder is tight on funds and that can mean trouble.  I wouldn't want to leave earnest money in that kind of risk situation.  If it were for custom upgrades and non-refundable that would be a different story.

What recourse would you have if the builder defaulted on the 5% note if you went that route?

Definitely, consult a local real estate attorney.

Answer 17

While I have never bought a new house, earnest money is typically held and applied toward the sale after escrow goes through.  It needs an account that cannot be accessed by the builder until the contract is fulfilled or broken.

What does your realtor say?  Your realtor, not the builder's.

I'd want to buy a house that was finished.  Too many things can go wrong waiting for one to be built.  For example, the builder can go bankrupt.

Answer 18

The economy is in trouble right now.  He could be trying to offset his financial woes or trying to make sure that he doesn't develop them.  There's nothing stopping you from checking out other contractors and their terms.  But regardless, I wouldn't part with that much money without some assurance that material will be purchased and labor will be performed.  Consult an attorney that specializes in real estate or at least talk to your banker, either should have a good idea about what the trend is.

Answer 19

That is not "earnest money" to a third party title co.  That is a down payment direct to the builder.  Run from this "deal."

Answer 20

Reputable builders will want to protect you as well as themselves.  They use trust and escrow accounts.  They all do in my area.  The only exception is if you are going through a bank to do "draws".

Only go forward if you can afford to lose the entire deposit.

If the builder cannot afford to get started, then he probably doesn't have enough capital to finish the project.  That would cause me to give pause.

Just because a builder is big, doesn't mean that they won't run into financial trouble.

Do what you want, but I would walk before I let someone talk me into a contract that gave them all the benefits and me no protection.

Answer 21

Absolutely not, and you'll never see it again if you do.  That sounds shady to me.

It is NOT COMMON at all.

Escrow and trust accounts are virtually the same thing.  It's money kept in an account that is frequently audited by regulators, must be protected, and cannot be "co-mingled" with normal operating funds.

By saying he won't put it in an escrow account is the SAME THING as telling you, "I am not going to guarantee your funds are protected."

In other words, if it's not a trust or an escrow account, then they CANNOT guarantee that your money is safe.

You CANNOT automatically ask for an escrow/trust account to be interest-bearing, because states laws are different, the majority of escrow/trust accounts are NOT interest bearing. In fact, in states like mine, they CANNOT be interest bearing.

If I were you, I wouldn't buy a house from them at all.  Anyone that starts out business that way, it's not going to turn out good.

PS:  It sounds like you do not have a Realtor.  Understand that builders budget for Realtor commissions and they will charge you the same even if you don't have one.  That way, you'll have representation and working with someone who knows how the game is played.

Answer 22

See a lawyer. There is no such thing as "common". Builders can structure a construction agreement any way they want to-- all it takes is your agreement. You didn't state whether you already own the land. If you don't own the land and the builder does, this seems a bit "suspect". Usually, you buy the land, and concurrently sign a construction agreement. You also need to be concerned about insurance during construction. Who owns the supplies and construction materials? Who is responsible if there is an injury on the property? You need special insurance coverage during construction. If the Builder owns the land, then your purchase should be structured like any other home sale, with a deposit into escrow, and inspections, and payment in full when you take possession. I wouldn't agree to pay him directly under that circumstance. That is when you put $ into escrow. See a lawyer, new construction has complex financial ( including building loan and bank requirements--they pay out in installments while construction occurs-then roll it over into a conventional mortgage) insurance and code compliance issues, as well as time considerations. It is much too complex an issue for this forum. Why should you give him a 5% promissory note? Is he financing your purchase? What if he doesn't perform as promised? If he fails to deliver, it can impact your mortgage commitment. Interest rates are rising... There is a lot to consider. I hope this explanation helps you. Good luck.

p.s.- you can require the builder to obtain a bond, in case he doesn't complete the work, you get paid to have someone else complete it. Look into that, too.

Answer 23

YEAH, most guys want to get money up front for materials.

Answer 24

no it is not common. but neither is the market regarding housing, finance, and the real estate inventory of new homes not being sold. Just verify in writting an cash exchanges and makes sure that you understand all terms in which you could forfiet the money you put down.

Answer 25

What type of contract do you have?  

1. Is the builder in a subdivision, building the house and when it's finished you settle with a regular loan.  

If this is the case, then 10% is a lot to put down.  We require 5% down and some builders are requiring as little as 1,500 down on a to be built 400k house.    We put our money into escrow until settlement. We are big enough where we don't need this money to start the house.  A lot of small builders, especially today, are not this financially sound.

If this is the case, I'm betting this is a small builder and he will use your deposit to start the house.  THIS IS NOT A GOOD IDEA.  You don't own anything until settlement, and if he goes out of business, you lose your deposit.  I would require that the money be put into a escrow account.

2. If the builder is acting as a general contractor and you own the lot and have a construction loan, then yes, this is very normal.  In this case, the builder is paid in draws after a stage is finished.  However, the builder has to front the money upfront, especially for permits, site plans, etc.  So 10% in this case is normal.  In Montgomery County MD, it costs $50,000 UPFRONT to get the permit/impact fees, etc.  (NOTE: this is on any house from 300,000 to 3m).  So yes! we require at least 10% down to cover these costs.  

In addition, the bank usually requires around 10% down on a construction loan.

Answer 26

Hello ,

I am from IL,   working in a realistate and a mortgage industry for   last 12 years. Be very careful , allot of builders going out of business this days and people loosing allot of money. They need to collect 10%  earnest money and sell 75% of units to get a constraction loan. Next year market prodiction even worce then this year, so you don't have to worry about them resaling your contract. To make my story short, you should hire an attorney and your attorney should check them out, how many units they already sold and for how long they  selling them, becouse if you just ask them, you will not get an thru answer. Be sure you can get a mortgage this days, it;s much more serios then you think, sale you property before you will close on a new one. Good Luck!

Answer 27

The earnest money accompanies the contract, however, I would be reluctant to place money directly in the hands of the builder rather than an escrow account with the title company.

Have an attorney draw up the contracts allowing for recourse in the event the builder does not live up to his end of the bargain.

Answer 28

They want the earnest money directly because their cash flow is tight. Like #1 says, they want it for materials, or labor, or whatever. Lots of builders are flipping over these days, even reputable ones. Exercise extreme caution. Here in Tucson, many high-end custom developers have declared bankruptcy, often with little or no indication beforehand. You'll be in line to get your earnest money back in bankruptcy court then, right in back of other creditors, employees, etc.