How to Use Your Earnest Money for a USDA Loan

Earnest monet graphicWhen you want to purchase a home, the first step is usually to find a house that you like. This is where your earnest money comes in. With your earnest money, you can show the seller that you’re serious about buying their house.

You’ll pay a deposit upfront that you can use to buy the house. If the seller accepts your offer, you have some period of time to forward your good faith deposit to a third party (i.e. real estate company, tile coompany, etc.).

What Is Earnest Money, And Why Do I Need It?

When you're buying a house, there are a lot of things to keep track of—like the purchase price, down payment, and closing costs. One important aspect of buying a house is the earnest money deposit. So what is earnest money, and why do you need it?

The earnest money deposit goes into an escrow account until the closing date. If you back out of the deal or if the seller cancels the sale, they can keep your earnest money as compensation.

How Earnest Money Works

When you are ready to purchase a house, your Realtor will provide you with a purchase agreement. This document is a contract between the buyer and the seller that outlines the terms and conditions of the sale. The earnest money deposit is one of the most important parts of this agreement.

If the buyer backs out of the sale, or if there is a problem with the title, the seller can keep the earnest money as compensation. If everything goes smoothly, however, it will be refunded to the buyer at closing.

How Much Earnest Money You’ll Need

When buying a home, you'll need to come up with money for closing costs and an earnest money deposit. The amount of your earnest money deposit will be based on the purchase price of the home. 

The amount of earnest money varies, but it's typically 1-3% of the purchase price.

For example, if you're buying a home for $200,000, you'll need to come up with between $2,000 and $6,000 for the earnest money. 

Your earnest money deposit will go into an escrow account until the sale is final. If you back out of the deal, you'll lose your deposit. If the seller backs out, they'll lose the deposit. 

The amount of money you'll need for closing costs varies depending on where you live.

When Do I Pay the Earnest Money?

There is usually a blank line in the sales contract that gives you some number of days to provide the earnest money to the real estate company, title company or escrow company.

How Earnest Money Refunds Work

A house sale might fall through for a variety of reasons, including structural issues with the property, a poor appraisal value, or a financial difficulty that prohibits the buyer from closing on the mortgage. If the sales contract has the necessary contingency, buyers will be able to obtain most, if not all, of their earnest money back.

Several possibilities might be covered by contingencies, including:

If you elect to waive the purchase contract's conditions, you're putting yourself in a lot greater danger. If they get many offers in a competitive market or an all-cash offer, some sellers may seek a contingency waiver.

If you wish to waive conditions, seek as much assurance from the lender as possible that your loan will be authorized. Even so, you'll have to pray that the house inspector doesn't find any big flaws and that the appraisal will come in at the needed amount.

If you cannot complete the buying process, including the appraisal and house inspection, within the time frame specified in the contract, the seller may be able to keep your earnest money. This is more probable if the seller includes a language in the contract that states that time is of the essence and that deadlines must be met.

You'll also lose the earnest money if you decide to back out of the transaction simply because you don't want to go through with it.


Contract Contingencies Protect your Earnest Money

A contingency in your purchase agreement is the only way to ensure you'll receive your earnest money deposit returned from escrow in any given circumstance. You may utilize a variety of scenarios to attempt to preserve your deposit, including:

Home inspection contingency: You can include a provision in your purchase agreement stating that if damage is discovered during the home inspection, your earnest money will be refunded. The home inspection report clause is usually applied to serious flaws like a roof that needs replacement or an HVAC system that must be replaced or repaired.

Appraisal contingency: If the property doesn't appraise for the purchase price, you'll receive your deposit back, which is significant since the lender can't offer you more than the house is worth. It may not go this far since sellers may be prepared to return to the negotiating table with you at this stage to make the deal work, but this isn't always the case.

Mortgage contingency: If your agreement contains a mortgage contingency, also known as a finance contingency, you may receive your deposit back if your mortgage financing fails.

Existing house sale contingency: If you're attempting to sell your present home while purchasing a new one, you might make the purchase conditional on the sale of your old one, so you don't have to pay two mortgage payments.

Purchase agreements are the result of negotiations. In many circumstances, a seller may not agree to every condition. Sellers who are very eager to sell their house may be offended if a buyer requests too many conditions in the purchase agreement, but it's fair to want some security. You should understand the conditions of your purchase agreement, so you know when and how you may get your money back.

What If I Can’t Afford Earnest Money?

Man with pockets turned inside outIf you're strapped for cash, using gift money from an acceptable source can solve your problem.

Earnest money can come from a friend or relative. Acceptable sources of gift funds include:

  • Employer or labor union
  • Family members
  • Charitable organization
  • Homeownership Assistance Grants and Programs

Gift money must be documented for the lender. They'll ask to see your bank statements and verify any major deposits, so be upfront about your funds.

You can also ask the seller to waive the earnest money deposit. This works best when the housing market is slow and the seller is eager to sell.

What Happens to the Earnest Money at Closing?

In most cases, the earnest money will be used to pay for the down payment or closing costs.

Conclusion

In conclusion, using your earnest money for a USDA loan is a great way to get started on the home buying process. It shows that you are serious about buying a home and that you are ready to start the process.

It also helps to get the ball rolling on getting pre-approved for a loan. If you are interested in buying a home, be sure to use your earnest money to get started today.