How Earnest Money Deposits Work With a VA Loan

Marcus Marion, CMA™ 1 month ago 0 9

When you use a VA loan to buy a house, you have the option to make an earnest money deposit when submitting your offer to the seller. Emphasis on the word “option.”

Earnest money deposits are entirely optional when using a VA loan. The Department of Veterans Affairs does not require earnest money for VA-backed home loans. Even so, a deposit could help you get your offer accepted by the seller.

In this article, you’ll learn how the earnest money deposit works, and how it relates to your VA loan when making a home purchase.

VA Home Loan Program Overview

VA loans are a special type of mortgage loan that receive federal backing through the U.S. Department of Veterans Affairs. They offer veterans, active-duty service members, and eligible surviving spouses a zero-down-payment mortgage option with flexible credit requirements.

This program essentially eliminates one of the biggest obstacles along the path to homeownership, which is the down payment. Eligible borrowers can finance 100% of the purchase price when using a VA loan.

This program also offers relatively flexible qualification criteria for borrowers. It’s arguably one of the easiest types of home loans to qualify for, due to the government guarantee given to mortgage lenders.

The Earnest Money Deposit

Most home buyers in the U.S. make an earnest money deposit when submitting an offer on a house. But it’s a custom and a tradition, rather than a legal requirement.

The earnest money deposit represents a financial commitment to the deal. It demonstrates the buyer’s serious intent to purchase a property and is usually submitted along with the purchase offer.

Earnest money deposits are held in escrow by a neutral third party until the sale is finalized. If the deal goes through, the funds will be applied to the down payment or closing costs. So it becomes an investment in the property.

However, if the buyer backs out of the deal without a valid reason, they might end up forfeiting the deposit. This is why some buyers include real estate contract contingencies that protect their earnest money in scenarios that are beyond their control.

We will talk more about these contingencies in just a moment. But first, let’s take a look at what the Department of Veterans Affairs says about earnest money deposits with VA loans.

They’re 100% Optional for VA Loans

As mentioned above, the earnest money deposit is entirely optional when using a VA loan to buy a house. They are not required or mandatory. This gives buyers more flexibility when it comes to structuring their offer.

The Department of Veterans Affairs publishes a handbook known as the “VA Home Loan Guaranty Buyer’s Guide.” This 51-page PDF guide (which is available online) explains to home buyers how the VA loan program works.

But this guide only mentions earnest money deposits in two places. The first reference is where the handbook explains some of the one-time expenses associated with a VA mortgage loan.

To quote that portion:

“Earnest Money Deposit – (Optional) This is a cash deposit used to hold a home you are bidding on. It shows that you are serious about purchasing that home.”

They revisit this subject when explaining the VA loan escape clause that home buyers can use in a low-appraisal situation.

As the buyer’s guide states:

“Remember to include in your sales contract, a contingency (called an ‘escape clause’) which allows you to not incur any penalty by forfeiture of earnest money or can void the contract if the contract purchase price or cost exceeds the reasonable value of the property established by the Department of Veterans Affairs.”

Understanding the ‘Escape Clause’

We explored the escape clause in a previous blog post about home appraisals with VA loans. So be sure to check out that article if you’d like to learn more on the subject.

Here’s the short version:

You can think of the VA escape clause as a safety net for your earnest money. If the appraiser appraises the house lower than the agreed-upon purchase price, you can walk away without losing that deposit. It’s your “get out of the deal” card if the value doesn’t match up.

This clause is required for all VA home purchase loans. It’s designed to protect borrowers (primarily military members and veterans) from financial losses due to factors that are beyond their control.

The Benefits of Making a Deposit

In a competitive real estate market, an earnest money deposit could make the difference between having your offer accepted, or having the home slip through your fingers. So consider it carefully.

In an active market, it’s fairly common for sellers to receive multiple offers for their homes. Sometimes these offers can stack up within a few days of the property coming onto the market. 

In a competitive scenario like this, home buyers must do everything they can to make their offers stand out. And the earnest money deposit is one way to accomplish that goal. It shows the seller that you are serious about buying their property and invested in the deal.

If you combine an earnest money deposit with a strong offer and a pre-approval letter from your mortgage lender, you could greatly increase your chance for success.

On the other hand, if you skip the earnest money deposit entirely, you’re giving the seller a reason to reject your offer—or at least to put others ahead of it. This is true when using a VA loan or any other type of mortgage program.

In summary: VA home loans do not require borrowers to make an earnest money deposit. They do, however, require an escape clause that protects your (optional) deposit in the case of a low appraisal. Though it’s not required for a VA loan, an earnest money deposit can give you an added advantage in the real estate market.

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