Many years ago, a girl from Kansas named Dorothy skipped along the Yellow Brick Road with her friends Scarecrow, the Cowardly Lion, and the Tin Man. They faced a forest of flying monkeys, a nasty & powerful witch, and a whole lot of unknown stuff on their quest to get to the enchanted city of Oz. At one point, they realized that they just might have to face some really scary stuff that they’d never seen before: “Lions and Tigers and Bears, oh my!”
Of course, I’m referring to the classic movie, “The Wizard of Oz,” for those who are reading this and wondering if I’ve lost my mind.
In this article, you’re going to learn the essential basics about some of the essential, scary COSTS in real estate – whether you’re buying (or selling) an investment property or a home to live in. Those costs are often intimidating and confusing to the uninitiated newbies who are skipping along their own Yellow Brick Road on their personal quest to financial freedom.
We’ll go over what you NEED to know so that you can stop feeling like the Cowardly Lion and instead sound & feel like a confident pro in no time! Ready? Let’s go…
Essential Cost/Expense #1: The Binder Deposit
The first thing you should know about is the Binder Deposit. This is also called the Earnest Money Deposit or Good Faith Deposit. This is the financial consideration (money) that the potential BUYER of a property gives the SELLER when they present their written offer.
Whenever a contract/written offer is presented for the purchase of a property, there needs to be some sort of consideration given. This is what demonstrates the seriousness about your intentions of buying a house. For a long time, it was said that this consideration could simply be “love and affection,” but due to the fact that this is something that’s difficult to prove in a court of law or whatever, it has come to be generally understood that the minimum amount you should give as a Binder Deposit is $10.
Naturally, whatever amount you give to the seller goes directly towards the overall purchase price of the property. If you just give them $10, it doesn’t matter much if it’s not counted.
TIP: Make sure that whenever you give this deposit amount to the seller by cash, check, or electronic payment/transfer (PayPal, Cash App, Venmo, etc.), you get the seller’s signature, acknowledging that they’ve received it!
If you’re buying a property that’s listed by a licensed real estate agent or if you’re buying a property from an institution (such as a bank), be prepared for them to request a LARGE Binder Deposit. Yes, this is something that you can negotiate down, but they may not like it & may not see you as a serious buyer if you’re not willing to commit something a bit more substantial. Also, if you give a large Binder Deposit, make it out to your closing attorney or title company’s escrow account. That way, it’s held by a third party so you have more control.
Finally, if you’re the one buying the property, and you decide to change your mind and not buy the property (or if you default on the deal), it is commonly understood that the seller is entitled to keep the Binder Deposit as their remedy. With that in mind, here’s a quick bit of advice: If you ever DO have to give a large Binder Deposit, make SURE that you have a decent CONTINGENCY clause in your Purchase & Sales Agreement that allows you to get that Deposit back if you have to pull out of the deal. An example of a contingency clause is “This agreement is subject to buyer’s inspection, to be performed within 14 days of acceptance.” That will help protect you.
By the way, if you’re assigning a contract for a wholesale (all cash) deal, there’s usually an Earnest Money deposit that’s given when the assignment of contract agreement is signed. Anything left over for the assignment fee is paid at the closing.
Pro TIP$: When you’re BUYING, you want to give the LEAST as a Binder Deposit.
When you’re SELLING, you want to collect the MOST you can get. Should be obvious.
Now that you know what a Binder Deposit is, let’s cover the next big cost…
Cost/Expense #2: The Down Payment
The Down Payment is what a buyer gives to the seller as part of their purchase price of the property. Not to be confused with the Binder Deposit, it is usually given in cash/cashier’s check/wire transfer, etc. at the closing. This entire amount goes towards the purchase, and is deducted from whatever amount is financed over time.
Since there are two ways that we buy houses – cash or terms, it should be obvious that when we buy for all cash, there is no down payment, since we pay everything & everyone in full at the closing. A down payment only comes into play when we are financing the purchase of real estate.
Further, since we do NOT buy like we sell, we will usually look to put as little to nothing down when we buy, whereas we will want to get as much as possible down when we sell or lease option the property out to our tenant buyers. Make sense? Good!
Of course, the amount that remains on the purchase price after deducting the down payment is the amount that is financed, and that amount (along with the other terms of the financing, such as interest and the term) is used to figure out how much the monthly payments to the seller will be. The exception to this is when we simply take over debt, such as a subject-to transaction or when we have the note that the seller takes back on a wraparound mortgage mirror the terms of their existing loan. In those instances, we’re just looking to start making the payments on that debt when we agree. No calculation necessary!
Something else to consider: When you agree to make a down payment to a seller, those funds don’t necessarily have to come from your pocket. There’s a thing called arbitrage, which is just a fancy word that means that you make money in the middle. In this case, it would mean the difference between the down payment you would agree to give the seller subtracted from the amount you’re able to get from your buyer or tenant buyer.
For example, if you agree to give a seller a $10,000 down payment for the purchase of their property, and you know without a shadow of a doubt that you’d easily be able to collect at least $20,000+ down from your tenant buyer in no time, would you look to get that property under contract? Assuming that the rest of the deal looked great, I hope you said yes!
Pro TIP$: When you’re BUYING, you want to give the LOWEST Down Payment (or none at all). When you’re SELLING, you want to get the HIGHEST down payment you can get.
We’re almost done! Now let’s cross the last great cost barrier on our journey down the Yellow Brick Road…
Cost/Expense #3: The Closing Costs
Ahhhhh…closing costs. These are the necessary expenses and fees that you need to take into consideration when you’re in the business of buying & selling houses.
Depending on where you’re doing business & buying houses AND what type of deals you’re doing, these costs can range from not so bad to downright painful.
Here are some examples of closing costs: Document (doc) stamps, transfer taxes, county taxes, loan/note origination fees, notary fees, doc prep fees, attorney’s fees, title insurance, title examination fees, recording costs, etc.
There’s a lot of fingers that go into that pie.
If you’re not careful, you might have a chunk of the profit of your deal sucked up by these closing costs, so be sure to educate yourself on how to mitigate these essential costs.
When you’re buying on terms & having to pay a decent down payment, do your best to at least split the closing costs. Same thing when you’re buying all cash – try to negotiate for the seller to pay most if not all of the closing costs when possible (a subject of debate among wholesale investors).
Pro TIP$: Whether you’re BUYING or SELLING, you’ll usually want to pay the LEAST amount of closing costs possible. A notable exception is when you’re buying on terms with nothing down (and getting some equity). That’s a time when you’ll usually pay all the closing costs, because you won’t want the seller to have to come to the table to pay them.
Now You Know The 3 Essential Costs of Real Estate
Now that you know how to Beat the Binder Deposits, Douse the Down Payments, and Kick the Closing Costs, you shouldn’t have to be scared anymore. In fact, you should hold your head high and smile at the fact that you now understand what all these costs are, and how they factor into your real estate buying and selling strategies a bit more than you did just a few minutes ago.
And with all that out of the way, you may now continue on your journey to financial freedom in real estate. Just like the Scarecrow, the Tin Man, and the Lion, you already have the brains, the heart, and the courage. All you need to do now is to (start singing)… “Follow the Yellow Brick Road. Follow the Yellow Brick Road. Follow the, follow the, follow the Yellow Brick Road!”
Of course, skipping is optional (but often encouraged). 🙂
Until Next Time,
Tony Pearl
