If you’re using a VA loan to finance your home purchase, it’s important to understand how earnest money may factor into this transaction. You may have heard this term–also known as a “good faith deposit”–throughout the homebuying process, especially in a competitive market.
But what exactly is earnest money, and how does it apply to VA loans?
Key Takeaways
- Earnest money demonstrates a buyer’s commitment and provides seller protection, typically 1-3% of the purchase price.
- It’s not required for VA loans but may still be requested by sellers.
- Funds for earnest money deposits must come directly from the buyer, not as a gift or loan.
- Offering earnest money can make an offer more competitive, especially in hot markets.
- Earnest money is refundable under certain contingencies, such as appraisal, inspection, or financing.
What is earnest money?
Earnest money is a deposit buyers provide to sellers when making an offer on a home. It’s usually 1-3% of the purchase price but can vary based on market conditions and other factors.
The primary purpose of earnest money is twofold:
- It shows the seller that the buyer is committed to purchasing the property
- It provides a level of protection for the seller in case the purchase agreement falls through.
When a seller accepts an offer, their home is taken off the market. If the buyer walks away without a valid reason, the seller can keep the earnest money as compensation for lost time and opportunities.
Is earnest money required for VA loans?
One common question among VA homebuyers is whether earnest money deposits are required. The good news is that VA loans do not mandate earnest money deposits. However, sellers may still request or even require earnest money along with your offer.
While earnest money is not mandatory for VA loans, it is a common practice in real estate transactions. The requirement for earnest money typically comes from the seller, not the loan program itself.
VA Loan Earnest Money Guidelines
The VA has specific requirements for earnest money deposits, particularly around their source:
- Funds must come directly from the buyer, not as a gift or loan
- The source of the deposit is verified to ensure the buyer has a personal financial stake in the transaction
This requirement helps lenders confirm that buyers haven’t taken on hidden debts, which could impact loan approval.
Earnest money is usually held in an escrow account managed by a neutral third party until closing. These funds remain secure and cannot be accessed by either party unless both agree.
Should I offer earnest money with my VA loan?
While VA loans don’t require earnest money, offering it can strengthen your offer and improve your chances in competitive markets. Consider these factors when deciding:
Market Conditions
The current state of the market plays a big role in determining whether a deposit would be a good idea. The buyer’s power in the market is usually low compared to the seller’s, which can make the process of homebuying intimidating. Multiple parties often compete for properties, and sellers decide based on the best offer.
Price of the Home
The house price plays an important role in determining the amount of an earnest money deposit. Higher-priced homes typically require larger deposits to show serious buyer intent and financial capability. This helps secure the property in competitive markets and shows the seller how serious the buyer is about the property. Lower-priced homes might allow for smaller deposits while still demonstrating good faith.
Local Norms:
Real estate customs vary by region, so consult a trusted real estate agent for advice on what’s typical in your area.
Along with these factors, consider the pros and cons of offering earnest money:
Pros
- Competitive offer: Including earnest money with your offer demonstrates your commitment and seriousness as a buyer, making it more attractive compared to those without earnest money.
- Strengthens relationship with seller: Offering earnest money shows the seller that you are willing to provide them with some level of protection in case the deal falls through. This can help establish a stronger relationship with the seller, potentially facilitating smoother negotiations and a more positive overall transaction experience.
- Buyer and seller protection: Earnest money serves as protection for both parties involved in the purchase agreement. If the buyer backs out of the deal without a valid reason, the seller can retain the deposit as compensation. On the other hand, buyers can protect their interests by including contingencies in the purchase agreement.
Cons
- Risk losing deposit: If you back out of the home purchase for reasons not covered by the contingencies in the purchase agreement—such as finding another home or changing your mind—you risk losing your earnest money deposit.
- Funds must come directly from the buyer: The VA requires that earnest money deposits come directly from the buyer’s own funds. While some other loan types may allow deposits from alternative sources, VA loans emphasize that the money must be yours. Lenders will verify the source of the funds to ensure you have a personal financial investment in the transaction.
- Limits offering power: Offering earnest money on one property restricts your ability to make multiple simultaneous offers on other potential properties.
How much earnest money should I offer with my VA loan?
Earnest money deposits typically range from 1% to 3% of the purchase price, but the exact amount can vary. In competitive markets, buyers may offer up to 10% to strengthen their offer, though this is uncommon.”
In a less competitive home market, buyers likely wouldn’t need to offer as significant of an earnest money deposit to make their offer stand out.
The size of your earnest money deposit will also depend on the property you are considering. For example, a smaller earnest money deposit is typical for existing home properties, but you may need to increase your deposit for a new construction property.
If you’re unsure about the appropriate amount of earnest money to offer, consulting with a reputable real estate agent is beneficial. These professionals can provide valuable insights and guidance based on their knowledge of the local market, helping you select the most effective offer for your specific circumstances.
What happens to earnest money at closing?
At closing, VA loan homebuyers have several options for handling their earnest money deposit. Often, the funds are applied toward closing costs or the loan’s funding fee. Since VA loans do not require a down payment, this is a common use for earnest money. In cases where the seller contributes toward closing costs or covers them entirely, homebuyers may receive some or all of their earnest money back. However, it’s important to note that sellers rarely cover all closing costs, so receiving the full deposit back is less common.
Is earnest money refundable?
Whether earnest money is refundable depends on the specific terms outlined in the purchase agreement. A “contingency” is a condition written into the contract that must be met for the sale to move forward. If a contingency isn’t satisfied, the buyer may be entitled to a refund of their earnest money deposit.
For example, if significant issues are discovered during a home inspection that the seller did not disclose, the buyer might back out of the deal and get their earnest money refunded. However, if the buyer decides to walk away without a valid reason outlined in the contract, the seller may keep the deposit.
Common Contingencies That May Protect Your Earnest Money:
- Appraisal contingency: If the property’s appraised value is less than the purchase offer, VA loans automatically protect earnest money through the VA escape clause.
- Inspection contingency: If the home inspection reveals unsatisfactory conditions, the earnest money may be refunded.
- Financing/mortgage approval contingency: If the buyer is unable to secure financing within a specified timeframe, the earnest money may be refunded.
- Selling contingency: If the buyer is unable to sell their previous home before closing, the earnest money may be refunded. However, this contingency is often unpopular with sellers.
What Is the VA Escape Clause?
The VA escape clause, or VA addendum, is included in all VA loan agreements to protect the buyer. This clause ensures you can walk away from the deal and reclaim your earnest money if:
- The property fails to meet the VA’s Minimum Property Requirements (MPRs).
- The appraised value is less than the purchase price.
This safeguard is a unique benefit of VA loans, designed to minimize financial risks for veterans and service members.
Additional Tip: When considering these contingencies for your purchase agreement, remember that they often have strict timelines. Ensure you meet any deadlines to keep your earnest money protected.
The Bottom Line
Earnest money can be an essential part of the homebuying process, providing benefits for both buyers and sellers. While VA loans do not require earnest money deposits, offering them can strengthen your offer, demonstrate your commitment, and foster a better relationship with the seller.
As you move forward in your VA loan homebuying journey, carefully consider the pros and cons of offering earnest money and be sure to understand the contingencies in your purchase agreement. By making informed decisions, you can navigate the homebuying process with confidence and find the perfect home for you and your family.
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Guide to VA Appraisal Fees and Process
The VA Loan Process: Explained
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