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The Money Factor

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Posted On: 12/30/2009

Q: To buy a house it looks like I have to come up with both a deposit and a down payment. Since money is money, what’s the difference?

A: There are big differences between a deposit and a down payment.

We usually think of contracts as arrangements that involve an offer, an acceptance and consideration. In the case of real estate, a seller says “my house is for sale,” but it’s actually the buyer who makes an offer to buy through the sale proposal presented to the property owner. Once the offer is made, the seller can accept, reject or counter the offer.

To have a valid offer you need some form of consideration from the buyer, the one making the offer. That “consideration” usually is a deposit. An offer might say that the buyer is willing to pay $400,000 for the property. To show that the offer is real, the buyer will also offer a deposit, say $10,000.

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A deposit, however, does not necessarily have to be in the form of cash. For instance, when homes are sold to family or friends it may be that nothing more than “good consideration” is involved -- love and affection.

If the buyer is putting up a deposit then what is the seller risking? By accepting the buyer’s offer the owner is effectively taking his home off the market and perhaps losing the opportunity to sell to other buyers for a higher price or better terms.

Today most real estate offers are actually “contingent” agreements that depend on such things as a certain appraised value, a professional home inspection satisfactory to the buyer and financing at no more than a particular rate. However, if the sale agreement falls through because the buyer did not perform as promised then the deposit can be lost.

Local customs vary, some standard sale agreement forms limit damages to just the deposit while others also allow a seller to sue for more money or even to demand specific performance. With specific performance a seller asks a court to force a buyer to complete the transaction, something rarely granted.

Many sale agreements say that if the deposit is lost the money will be divided between the owner and the broker, up to the value of the commission.

Deposits typically are held in a broker’s escrow (trust) account. This means that neither the broker nor the seller can touch the money without permission of the buyer. If there’s a dispute, the broker will usually hand the deposit money over to a court.

If the agreement goes through to closing the deposit counts as a credit toward the sale.

From a negotiating standpoint, if you’re a seller you want the largest possible deposit while buyers want to offer the smallest deposit they can.

A “down payment” is different. When you finance real estate your lender would really like you to purchase with at least 20 percent down to limit his risk. In practice, few people have 20 percent down so they buy with such programs as private mortgage insurance, FHA backing or through the VA.

The down-payment money must be delivered at closing. In addition to the down payment, buyers also are likely to need additional cash for closing, which depends on the cost of the home, how you negotiated the sale agreement, whether the lender is paying any closing costs and where you live.

For instance, most loan programs allow owners to make “seller contributions” to offset buyer closing costs. Most owners, of course, have absolutely no interest in making such “contributions” because seller credits to buyers are simply a discount against the price. However if a market is slow than a seller contribution may be one way to make a home more salable. While most loan programs will allow seller contributions, they generally limit the amount of the discount to 3 to 6 percent of the sale price. The seller contribution must be part of the sale offer and shown in writing. Lenders can tell you more.

To know how much will be due in cash at settlement, buyers will need to get a Good Faith Estimate of closing costs. A GFE that should give buyers a clearer picture of what will be owed at closing and how much the lender is charging for his or her services.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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