Escrow alternatives: bond, letter of credit Both easier to access, verify than deposits

March 22, 1998|By Robert Nusgart | Robert Nusgart,SUN REAL ESTATE EDITOR

Although escrow accounts may be one of the more popular ways builders handle deposits from homebuyers, surety bonds and letters of credit also can be used.

There are pros and cons to each, according to John Nethercut, assistant attorney general in the Consumer Protection Division. "The bond or the letter of credit are good in the sense that they are, unlike a bank account, easier to get at and verify," Nethercut said.

"The good thing about the bonds and letters of credit is that they are publicly filed; the bad thing is that there may not be 100 percent recovery," he said.

Nethercut explained how a builder's surety bond and letter of credit work.

"If you are going to have a bond or a letter of credit, the amount of the bond or the letter of credit is dependent on the total amount of deposits being held by the builder," Nethercut said. "So, in other words, it's not that there is a dollar in the bond for every dollar that is being held. There are certain limits."

He said that if a builder has $500,000 or more of deposits on hand, the limit by law that a builder must post is a $500,000 surety bond. Even if the builder is holding, for example, $1 million in deposits, the builder still only has to have a surety bond of $500,000.

"So if a builder went out of business, they [consumers] would only get 50 cents on the dollar," Nethercut said.

Nethercut said the same limits apply to letters of credit.

"For example, for a huge builder, they could post a $500,000 letter of credit and take as many deposits as they wanted, and that's probably what a huge builder would do rather than bother with a lot of [small] accounts," he said.

Nethercut said the bank usually will ask for more collateral than what the letter of credit is worth before granting the letter.

"So there may not be any deposits anywhere, but what it does is it makes the letter of credit practically cash," he said. "It can be demanded and cashed in very easily, but the bank then will have a headache trying to collect, but that's the bank's problem. That's why [buyers] want a letter of credit; it removes from the consumer the collection burden.

"On the other hand, there should be a dollar of escrow money for every dollar of outstanding deposits, unlike the bonds and the letter of credit.

"You may have more in the escrow account, but the problem with the escrow account is that what we are seeing here is that it is harder to verify and harder to get a hold of once something goes wrong."

Pub Date: 3/22/98

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