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?
What is earnest money?
Earnest money refers to a deposit the buyer pays to the seller when making a purchase offer on a home. It is typically a percentage of the home’s purchase price ranging from 1-3%, although the chosen amount can vary.
The primary purpose of earnest money is twofold: it shows the seller that the buyer is committed to purchasing their property and provides a level of protection for the seller in case the purchase agreement falls through.
Once the seller accepts a buyer’s offer, the property is taken off the market during the closing process. If the offer were to fall through, the seller would have to start the selling process over again, potentially losing valuable time and opportunities. By offering earnest money, serious potential buyers can help to reduce this risk for sellers.
VA Loan Earnest Money Guidelines
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 earnest money along with your offer.
For those VA loan borrowers who decide to include earnest money in their purchase offers, the VA does have specific requirements regarding the deposit’s source.
The funds for earnest money deposits must:
- Come directly from the buyer
- Not be sourced from a gift or loan
By verifying the source of the deposit, the VA aims to ensure that the buyer has a personal financial stake in the transaction, reinforcing their commitment to the offer and ability to fulfill their obligations.
Should I offer earnest money with my VA loan?
Although earnest money is not required with a VA loan, you may still consider it when making an offer on a potential property. When making this decision, buyers should consider factors such as current market conditions, along with the various advantages and disadvantages of offering earnest money.
See the chart below for an overview of the pros and cons of earnest money deposits:
Pros and Cons of Earnest Money Deposits With VA Loans
Offering earnest money with a VA loan can provide several advantages for homebuyers:
- 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 a form of 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.
Along with its advantages, there are also several disadvantages of including earnest money in your purchase offer to consider when deciding if this approach is right for you:
- Risk losing deposit: If you decide not to proceed with the home purchase for reasons not covered by the purchase agreement’s contingencies, you risk forfeiting your earnest money deposit. Carefully consider your commitment level before offering earnest money to minimize this risk.
- Funds must come directly from the buyer: The VA requires that the funds for the earnest money deposit come directly from you as the buyer. The source of these funds will be verified 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?
While a typical earnest money deposit ranges between 1-3% of the purchase price, the exact amount largely depends on specific circumstances.
In more competitive markets, buyers may offer as much as 10% of the purchase price toward their earnest money deposit to strengthen their offer against competing buyers. However, 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, it’s beneficial to consult with a reputable real estate agent. 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?
Typically, earnest money is placed in an escrow account managed by a neutral third party until closing. Neither the buyer nor the seller can access these funds unless both parties agree.
At closing, VA loan homebuyers have options regarding the fate of their earnest money deposit. In many cases, the funds are applied to the loan’s closing costs or down payment. However, since VA loans do not require a down payment and closing costs are often paid by the seller, VA homebuyers will often receive their full earnest money deposit back.
Is earnest money refundable?
In most cases, if the buyer decides not to proceed with the home purchase, the earnest money deposit may go to the seller. However, purchase agreements usually include contingencies that protect the earnest money deposit and allow it to be refunded to the buyer under specific circumstances.
Here are some common contingencies included in a purchase agreement:
|Appraisal contingency*||If the property’s appraised value is less than the purchase offer, VA loans automatically protect earnest money.|
|Inspection contingency||If the home inspection reveals unsatisfactory conditions, the earnest money may be protected.|
|Financing/mortgage approval contingency||If the buyer is unable to secure financing within a specified timeframe, the earnest money may be protected.|
|Selling contingency||If the buyer is unable to sell their previous home before closing, the earnest money may be protected. However, this contingency is often unpopular with sellers.|
*Appraisal contingencies are always included with VA loans to protect the borrower’s money if the appraisal is low.
Additional Tip: When considering these earnest money contingencies for your purchase agreement, keep in mind that they may only offer protection within a set timeline.
The Bottom Line
Earnest money can be an essential aspect of a VA loan homebuying process, providing benefits for both buyers and sellers. While VA loans do not require earnest money deposits, offering it 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.