Good judgment comes from experience. Experience comes from bad judgment. How much money have you spent on deals that never closed? If you’re like me, you don’t want to know.
The money lost on deals that never close
When you’re first starting out you make a lot of mistakes. I remember ordering title searches, appraisals and credit checks on deals without even having a signed purchase contract!
I finally wised up, and for years I waited until the contract was signed before I paid for those things. Know what? I still got stiffed. A contract doesn’t mean a thing to many people (I’m tempted to say most).
Unless I was willing to sue them, which would have cost me a lot more than I had lost, I just put up with the losses and wrote them off as “the cost of doing business.” I don’t do that anymore, and I don’t get stiffed, not much anyway. If you’re in business you will be ripped off, and the more business you do, the more vultures you find circling around you.
How the escrow deposit method works
When we buy a note, we now do it a little differently. After reviewing the intake sheet and deciding we want the note, our next step is to negotiate a deal and get the seller’s signature on a purchase contract.
Then we get the standard documents:
- The settlement sheet (property closing statement)
- The note and the security instrument (mortgage, trust deed or contract)
- Title insurance information
- Photos of the property
- Anything else the seller has or can get, such as an appraisal or proof of insurance
Sounds pretty normal so far? Just wait. After reviewing the documents, we require the note seller to sign over the note and security instrument to us, along with all the necessary notifications and a check for $500. All of it goes to our escrow agent (I like to use an attorney of my choice).
Remember, this is long before the note seller sees any money. We don’t spend a dime or another moment of our time on the note until he has done this.
Our purchase contract says that if the seller backs out, his “Escrow Deposit” (described to him as his “Good Faith Deposit”) is forfeited to us. If he keeps his word, he gets it back.
The headaches the deposit solves
This method solves some of the major headaches of the note closing process. How many times have you made a deal, only to find out the note seller was stringing you along while he shopped around for a better price?
How many times has a seller developed cold feet at the last minute? Or his spouse vetoed the sale, or he decided he likes that monthly income after all, or his plans fell through. Sometimes you never learn the reason, because he simply stops returning your calls.
We no longer pay for title searches, appraisals and credit checks on notes we never buy. Now the seller has a real incentive not to shaft us. If he does, that $500 goes a long way toward soothing hurt feelings.
What to do when a seller refuses
What if the seller refuses? Well, what if you won’t buy his note? Suppose you applied for a loan, were told to supply your last two years’ tax returns and an application fee, and you refused. Would the loan company say, “OK, we’ll just go ahead anyway”? Of course not.
Don’t act as if the note seller is doing you a favor. From loan-to-value requirements to property types to document requests, far too often I see buyers back off their own standards just to land a note. As I can tell you from personal experience, when you ignore key criteria because you don’t want to lose a great deal, more often than not you’ll regret it.
The next note is as close as the next phone call. When I worked for an enthusiastic congressman who was out to change the world, and we’d lose a battle, I’d remind him, “Congress will be in session next year.” (I didn’t remind him he might not be part of it!)
Sure, sellers aren’t exactly coming out of the woodwork, but the note holder doesn’t know that. If your marketing brought him to you, you have a note holder who is worried about whether you will go through with the deal, and who wants to keep you happy.
Besides, do you really want to do business with someone who fights you over sending papers to escrow and a token, refundable “good faith” deposit? I learned long ago that life is smoother, and I’m happier, when I avoid doing business with contentious people. Your time is your most valuable asset. Spend it with people you enjoy dealing with.
When waiving the deposit wins the deal
Now that I’ve sounded so wise, let me make a confession: I don’t always follow my own advice. One thing I love about negotiations is that no two are alike. Another is that I almost always learn something new from each one, whether I make a deal or not.
In one note deal, I didn’t ask the seller for an escrow deposit. I felt I didn’t need one, that purchase had lower up-front costs than most, and it was very effective in the negotiation to cross out the clause in the contract with a big red X. It was visually powerful, too.
It was another building block in the image I always try to build in negotiations: that I’m a heck of a nice guy to do business with. I said:
“This clause is here so that if you back out, I won’t lose any money. However, I feel so comfortable dealing with you that I’m not worried about it one whit. I’m not going to presume upon what I hope will turn into a new friendship by asking you to prove your honesty with money. I know you won’t leave me holding the bag.”
Don’t think this is some smarmy sales pitch. I really meant it. I could have been wrong and ended up eating a hundred bucks, but I believed the risk-reward ratio was in my favor. The risk of losing $100 was smaller than the reward of using the clause as a negotiating tool. That concession may have clinched the deal, and I’ll make a lot more than $100 with that note.
Use a complete transaction checklist
Whether or not you use the escrow method, work every purchase from a complete transaction checklist, the same one every time. If you skip the escrow deposit, simply ignore the escrowed items on the list.
A good checklist streamlines and simplifies both due diligence and closing. It keeps you from paying for searches and reports before the seller has committed.
