Escrow in a real estate transaction tells the seller that the buyer is interested enough in buying their property to risk money to prove it. In some states, an escrow is required to bind the contract, but in most areas the “for good and valuable consideration” clause includes the purchase value of the property.

However, for a seller, escrow is a necessary evil that they seek not to lose, and often even after the inspection period has passed. If there is a contingency in the sales contract, the security deposit can be refunded after many painful days of waiting for buyer financing to be approved. All the time the property is off the market and the seller never knows for sure if the buyer will close.

Whenever a buyer is doing conventional financing, the contingent financing section should not list specific interest rates or terms, but should say “current rates” in case the buyer doesn’t get exactly what they wanted and tries to use this like an exhaust. clause to recover your security deposit. The seller is the big loser if the buyer does not pay and loses time, money and has to start selling the property all over again. The seller is worth the deposit as the buyer must have financing from him before attempting to purchase a property.

So how much would an escrow need to be for both parties to be at least equally unhappy or equally satisfied? The quick answer for a seller is as much as possible and for a buyer as little as possible. But more than just what they want comes into play because too big a deposit will kill too many deals, and too small a deposit will make too many buyers walk away.

In the real world, FNMA (Federal National Mortgage Association) is a big seller of REO (bank owned) properties. They have established a policy that requires 10% of the purchase price as a security deposit requirement. As they search for serious buyers, what has happened is that this onerous amount prevents many buyers from seeing their REOs. The idea was good, the implementation and the consequences were not understood by the FNMA management.

For wholesale real estate deals, the wholesale seller probably has the property under contract to an original seller and has given that seller a deposit in the range of $500 to $2,000. This can vary wildly and just last week an associate put down a $40,000 escrow on a $300,000 property because he had already sold it for $350,000 and had a $50,000 deposit from his ultimate buyer. This example is typical of an investor who is wholesale-selling a property that has an escrow at risk; he simply gets a larger deposit from the ultimate buyer of him. If the final buyer does not close and the investor decides not to close, he still makes money on the spread between the two deposit amounts, in the above case $10,000.

For a retail or end-buyer who will live in or own the property, I have found it comfortable to request the deposit amount I actually want at contract signing and the second half after a 10-day inspection period in which time, both deposits become non-refundable for any reason, including the buyer’s inability to obtain financing.

If I buy a property from an owner, I always offer only $100 as security deposit. Some investors brag about giving a homeowner a $1 deposit and that will work, but faced with a decision between $1 and $100, most homeowners would believe $100 is more credible. With homeowners, I also don’t pay the deposit until the inspection period is over, which is usually 30 days or more. The reason is that as a wholesaler I am looking to resell the property long before I have to close.

In short, getting an escrow is critical for a seller and the amount should be at least 3% to 5% or more of the purchase price. If the buyer is highly motivated, he may ask for 10%-20% to prove his sincerity. The problem is not the size of the deposit; is if the buyer closes. You could have buyer’s remorse, the property could fail inspection, or even have title issues that can ruin the sale.

The next problem is how does the seller get the escrow from their closing agent or from the buyer? This is not as simple as it sounds, as both the buyer and the seller must sign a Release in order for the agent to distribute the escrow. Check with the closing agent before you purchase the property to find out what type of release clause you can include in your original sales contract to overcome this problem before it becomes a problem.