When considering an investment in a used condominium, many investors wonder how the "earnest money deposit" works. By correctly understanding the types of earnest money, the typical amount, the payment timing, and what happens in the event of cancellation, you can complete a real estate transaction smoothly.
Why are returns on used condominium investment high?
The greatest appeal of investing in used condominiums is the high yield. Because the acquisition price is lower than for newly built properties, the net yield is higher even when rent is set at a similar level.
Net yield = (annual rental income − expenses) ÷ property purchase price
With relatively new used properties, it may also be possible to set rent at a level comparable to new construction, so in some cases yields in the 5% to 8% range can be achieved.
What is an earnest money deposit in real estate investment?
An earnest money deposit is a payment made by the buyer to the seller when concluding a real estate purchase agreement to prove that the contract has been formed.Its delivery indicates that both parties have expressed their intent. There are three types of earnest money deposit.
Cancellation deposit
A cancellation deposit is used to reserve the right to cancel. As long as contract performance has not yet begun, the buyer may cancel by forfeiting the deposit, and the seller may cancel by returning double the deposit. This is the most common form.
Penalty deposit
A penalty deposit is an earnest money deposit that is forfeited separately from damages if a contract breach occurs. If the seller is in breach, the seller must pay double the deposit.
Proof-of-contract deposit
A proof-of-contract deposit is used to demonstrate that the contract has been formed, and the amount is often set low. It is rarely used on its own, and it is more common to combine it with a cancellation deposit or a penalty deposit.
How are the typical earnest money amount and payment timing determined?
Typical amount and statutory upper limit
A typical earnest money deposit is about 10% of the sale price. If the seller is a licensed real estate business operator, the legal upper limit is set at 20% of the sale price.
Basic rule on payment timing
In principle, the earnest money deposit is settled by deducting it from the purchase price when the remaining balance is paid. To simplify the transaction, in many cases the contract is made for the amount remaining after subtracting the deposit from the total purchase price. An interim payment may also be required in some cases, but it is not mandatory and is determined by agreement between the parties.
Three points to keep in mind about earnest money deposits
1. The difference from an application deposit and a down payment
An application deposit is paid to the real estate company to show intent to purchase, and after the contract is concluded it is generally applied toward the earnest money deposit. A down payment is prepared as the buyer’s own funds; it has no legal definition, but in practice it is treated as earnest money.
2. Understanding the deadline for cancellation
An unconditional cancellation using a cancellation deposit is allowed only "until one of the parties begins performance of the contract". Once delivery or registration of ownership transfer begins, unconditional cancellation is no longer possible. Early decision-making is important.
3. Distinguishing it from a financing contingency
"Cancellation under a financing contingency" and "cancellation by forfeiting the deposit" when a loan screening is not approved are different systems. A financing contingency is a special clause for consumer protection, and there is no need to forfeit the deposit.
For the financing plan for used condominium investment, you may also refer to Comprehensive skills required for real estate investment.
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Frequently Asked Questions (FAQ)
Q1. Is an earnest money deposit always necessary for used condominium investment?
In real estate transactions, paying an earnest money deposit is common practice. It is not a legal requirement, but in practice it is almost essential as evidence of the contract.
Q2. How much earnest money deposit should I prepare?
A common guideline is 5% to 10% of the sale price. If the seller is a licensed real estate business operator, the legal upper limit is 20%.
Q3. Can I stop the purchase after paying the earnest money deposit?
If performance of the contract has not yet begun, unconditional cancellation is possible by forfeiting the cancellation deposit. However, once performance has begun, ordinary damages are generally required.
Q4. If the loan is not approved, will the earnest money deposit be returned?
If the financing contingency is clearly stated in the contract, the earnest money deposit will be returned if the contract is canceled because the loan was denied.
Q5. What is an interim payment?
It is an optional installment paid between the earnest money deposit and the remaining purchase price. It is used to level cash flow in high-value transactions, but it is not mandatory and is determined by agreement between the parties.
