Earnest Money DepositUpdated: November 9, 2022
Your earnest money deposit is an integral part of the home-buying process. It’s a good-faith deposit homebuyers provide to show sellers they are serious about buying a home.
Here’s how it works.
What Is an Earnest Money Deposit?
After buyers and sellers go under contract, closing on a VA home loan sale can take 30 to 45 days, according to the VA. That’s a long time for sellers, who must turn away other potential offers while they work with you.
Earnest money mitigates some risk for sellers because it serves as consideration – or value – between a potential homebuyer and the seller.
A buyer’s earnest money deposit acts as a sign of good faith. It shows the seller you are serious about buying a home. If the buyer walks away without a good reason, the seller can keep the earnest money.
However, buyers can leave the deal and keep their earnest money deposit in certain situations.
What Happens to Earnest Money at Closing
Once under contract, buyers can deposit earnest money into an escrow account. A title company or a real estate attorney can manage funds in escrow until closing to avoid potential conflicts with the seller.
When you close on the house, the earnest money will go toward your closing costs or down payment. For instance, if you provide a $1,000 earnest money deposit, you’ll receive a $1,000 credit on your settlement statement.
If you don’t close on the purchase, the reason the deal fell through will determine what happens to the earnest money.
Can I Get My Earnest Money Deposit Back If the Deal Falls Through?
When buyers back out of a deal, the seller may keep the buyer’s earnest money if the buyer breached the sales contract.
However, sales contracts include contingencies that allow buyers to keep earnest money when they walk away from a deal.
Read on to learn about contingencies that allow buyers to keep earnest money when a deal falls through.
Home Inspection Contingency
Home inspection results are one reason buyers may walk away from a deal.
Professional home inspectors create detailed reports when they examine a home, noting the current condition of the house and its major appliances. Home inspections can uncover thousands of dollars (or more) in needed repairs, such as roof damage, code violations, or damaged HVAC systems.
If a significant repair issue arises, buyers and sellers must negotiate responsibility for completing those repairs. If the seller doesn’t work with the buyer on the repairs, the buyer can back out of the deal and keep the earnest money deposit.
Home Appraisal Contingency
Mortgage lenders require a home appraisal before approving a mortgage. Appraisals protect buyers and lenders from financing a home priced much over its actual value.
For example, say the contract price on a home is $350,000, but the home appraisal came in at $300,000.
In this case, the lender may not finance the full home purchase price, and the buyer can walk away from the deal with the earnest money deposit.
However, consider using your home appraisal to negotiate a lower purchase price before leaving a deal. If the seller doesn’t lower the price to match the appraisal, you can still walk away from the deal.
Mortgage Approval Contingency
Many sales contracts include a mortgage approval contingency. This means buyers can keep their earnest money if they fail to qualify for financing.
For this reason, sellers may require a lender’s pre-approval letter before accepting an offer. The pre-approval guarantees the buyer will qualify for the mortgage unless unforeseen circumstances arise.
Current Home Sale Contingency
Lastly, some homebuyers must sell their current home to purchase a new one.
A current home sale contingency protects buyers in these situations. If buyers can’t sell their current home, they can walk away from the new home purchase with their earnest money in hand.
In particularly competitive real estate markets, some buyers may waive contract contingencies to make their offers more attractive to sellers. However, doing this eliminates buyer protections.
Keep contingencies in your contract unless you’re comfortable forfeiting your earnest money deposit.
How to Protect Your Earnest Money Deposit
Buyers can take a few proactive steps to protect their earnest money deposit.
Use an Escrow Account
Don’t deliver your earnest money deposit directly to the seller. Even if a contingency protects you, the seller could refuse to return your deposit. Recovering it may require a lawsuit, which costs time and money.
To avoid conflict, deposit earnest money in an escrow account managed by a real estate attorney or title company.
Know Your Contingencies – and Their Timelines
Contingencies may only offer protection within specific timelines.
For instance, a home inspection contingency may mandate a specific window for buyers to inspect the property and make a decision. If you fail to complete the inspection before this window ends, you can lose your earnest money – no matter what problems the report uncovers.
Put It All in Writing
Homes are a huge purchase. Therefore, you should include every possible contingency and associated timeline in your contract. Document any changes to these contingencies in the original agreement or in an addendum.
Doing so can give buyers and sellers certainty about earnest money rights if the deal falls through.
How Much Earnest Money Should I Put Down?
There’s no rule for how much earnest money a buyer should provide. Deposits may vary in size but usually fall between 1% to 3% of the contract price, according to the National Association of Realtors.
Here are some factors to consider to help you decide how much earnest money to put down.
Off-market vs. MLS Properties
Property investors may pursue off-market homes with less competition from other buyers. When there’s less competition, buyers can offer less earnest money.
Buyers searching for a primary residence on the Multiple Listing Service (MLS) may offer more earnest money to stand out from other buyers offering for the home.
Buyer’s vs. Seller’s Markets
Housing demand may influence earnest money deposits.
In a seller’s market, there’s more housing demand than the available supply. Sellers have the upper hand in negotiations, so buyers may offer more earnest money to get their offer accepted.
In buyer’s markets, supply exceeds demand, leaving homes on the market longer and giving buyer’s the upper hand. In buyer’s markets, sellers may accept lower earnest money deposits to get their home under contract.
When in doubt about your local housing market, ask your real estate agent. An experienced agent or realtor can recommend a suitable earnest money deposit.
Is Earnest Money Required for a VA Loan?
The VA does not require buyers to include earnest money in an offer. However, many sellers expect it, so you may want to consider offering it anyway.
Depending on your market, sellers may not consider a purchase offer that doesn’t include an earnest money deposit.
VA Appraisal and MPRs
When using the VA loan, a VA appraiser must confirm that the property meets specific habitability standards. In particular, homes must be safe, structurally sound, and sanitary, according to the VA’s lender handbook.
To meet these standards, the VA imposes minimum property requirements (MPRs) on properties. If a home fails to meet these MPRs, a VA appraiser will annotate issues on the appraisal report, and the VA won’t approve the loan until the seller resolves the problems.
Conceptually, MPRs should fall under any home inspection contingency. But, to provide the seller full disclosure – and protect yourself – include a specific VA appraisal and MPR contingency in your contract. That way, if the property fails to meet the VA’s MPRs, you can walk away with your earnest money deposit.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.