An earnest money deposit, or "good faith deposit," is an initial payment offered to sellers by homebuyers to show they're serious about purchasing the home. It's typically deposited when the sales contract is being signed, and can be applied toward closing costs or returned to the buyer at the end of the homebuying process.
That said, an earnest money deposit is not a lending requirement for a VA loan, though having one could help you stand out from other homebuyers. Should you provide one, and if so, how much? Below, we'll break down earnest money deposits and when it’s the right time to offer one.
Earnest money is an initial cash deposit that serves two main purposes: first, it gives your contract with sellers value or "consideration." Second, it shows sellers that you're making a serious offer. When the earnest money is deposited, sellers feel more comfortable removing the home from listing sites, or even rejecting other offers, as the deposit shows you're "earnest" about buying their home.
Usually the earnest money is held in an escrow account, which is managed temporarily by a third party (called the "escrow agent"). Once the money has entered this account, neither buyer nor seller can withdraw it, unless both parties agree on its release.
No, you don't need to put down an earnest deposit to complete the VA loan process. That said, putting down earnest money with a VA loan could help you compete with other homebuyers, especially in a hot seller's market where home supply is low.
Hopefully, you and the seller agree on a final price and take the offer all the way to the closing table with no problems or cause for concern. That said, your contract with the seller will likely have contingencies built into it, which allow you to walk away from the deal if something unexpected arises, such as a lower appraisal or hidden damages revealed in an inspection.
What happens to your earnest money deposit if the deal falls through? Like your contract, your earnest deposit has contingencies that will determine when your deposit is refunded to you. There are four types of contingencies that you may run into during this process.
If the home inspection shows the house is in poor condition, the inspection contingency allows you to walk away from the deal with your earnest money firmly in hand.
For appraisal values that are lower than the purchase price, the VA protects your earnest money under the appraisal contingency. This is also called the VA Amendatory Escape Clause.
If you're unable to secure the necessary funding in time, the financing contingency ensures you will be refunded your earnest money.
Buying one home while selling another is a tricky process. And if you can't sell your home before closing on a new one, the selling contingency says you can get a refund on your earnest money.
At closing, the earnest deposit can be applied toward closing costs. If the seller pays for these costs, then you will get your earnest money refunded to you.
As far as how much earnest money you should deposit, you should consider a few factors:
A general rule of thumb is to put down around 1% to 3% of the purchase price as an earnest money deposit. In markets where there's stiff competition, however, you might want to put down 3% to 5% or even more to stand out from other homebuyers.
Perhaps no factor can influence how much earnest money sellers expect from you than the overall state of the real estate market.
In a buyer's market, for instance, home supply generally exceeds demand. Buyers typically have the upper hand in negotiations, and sellers won't expect large earnest money deposits, if any at all. In this case, a 1% to 3% earnest money deposit should be sufficient.
On the contrary, in a seller's market, homebuyers have to compete for a limited supply of houses. Here, sellers are able to increase home prices, including earnest money deposits, because the supply of homes is lower. In these markets, you might want to put down more than 3% as an earnest deposit, as it can help you compete with other buyers.
Earnest money deposits help establish trust between buyers and sellers. Even if they're not required for the VA loan process, offering one could significantly improve your chances of closing on a home, especially if you're competing in a seller's market. If you're still unsure, you might want to speak with a real estate agent that specializes in VA loans to learn more about the process, or to make suggestions as to how much earnest money you should put down.