Both earnest money and down payments are real estate terms that have to do with buying and selling a home—but the differences between them can get confusing. If you’ve found your dream home, you should be ready to pay both: here’s what you need to know.
If you’re on the housing market, chances are you’ve heard words like “earnest money” and “down payment” thrown around by your real estate or insurance agent—but what, exactly, do those terms mean, and how do they affect you?
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Earnest money vs. down payment
Both earnest money and down payments are important to closing the deal on a property. Earnest money helps jumpstart a deal and keep both parties accountable in the sale; down payment money ultimately helps close out the sale.
Earnest money deposits aren’t always required—but they do help show commitment on the part of the buyer and may make a seller more willing to accept your offer and move quickly on closing out the deal.
Here’s a closer look at the differences.
What is earnest money?
Earnest money is a “good faith” payment made on the part of the buyer to show commitment to the purchase of a property. Making an earnest money deposit indicates to sellers that you (the buyer) are serious about closing the deal on a home.
Usually, earnest money is paid at the time the purchase agreement or sales contract is signed—however, it can also come attached to an offer to help a buyer stand out amongst stiff competition.
In any case, earnest money is typically deposited into an escrow account and held by a third party until the time of closing, after which the funds can be channeled toward closing costs, including your down payment.
Earnest money serves the dual function of holding the buyer accountable for following through on a sale and ensuring the seller doesn’t take a financial “L” if the deal unexpectedly falls through. While not necessarily a requirement of sale, an earnest money deposit can be beneficial for both buyer and seller, as it helps jumpstart the closing process.
Key Takeaway Earnest money is a good faith payment that holds the buyer accountable for following through with the sale. It’s not a requirement, but it could give you an edge in a competitive market.
What is a down payment?
A down payment, by contrast, is an upfront cash payment—typically at a percentage of the total cost of the property—-and an essential part of every home purchase.
Down payments are made directly to the seller and go toward the dollar-for-dollar amount of the property. Unless you’re buying your home fully with cash, you’ll likely finance the remaining cost of the property after you’ve paid the down payment—with the remainder becoming your monthly mortgage payment.
No matter what your situation, you can expect to make a down payment whenever you buy a new home. Down payments are a necessary part of finalizing the deal and transferring the property from seller to buyer.
Key Takeaway You may be able to get an earnest money deposit refunded if a sale falls through; but once you make a down payment, it’s non-refundable.
How much do I have to pay?
Generally speaking, an earnest money deposit is between 1% and 3% of the property’s total value. So, if your dream home is priced at $350,000, you’d want to make a good faith payment of at least $3,500 to show you’re serious.
The average U.S. down payment is about 6% of the total cost of your mortgage loan. So, if you decided to mortgage a $250,000 property, you’d probably make a down payment of around $15,000. Of course, local and regional market factors may impact just exactly how much you wind up paying.
What is the money used for?
When it comes to applying your cash, both earnest money and down payment money help secure your purchase of a property.
Earnest money signals the intent to buy, and is held in escrow until the time of closing—after which, it can be applied toward closing costs like your down payment.
Your down payment goes directly toward the purchase price of the home, and helps determine the amount and interest rate of your mortgage. A larger down payment will make for a lower mortgage (and a lower interest rate). On the flip side, if you’re making a smaller down payment, you’ll likely see a higher monthly mortgage and interest rate.
The difference between earnest money and down payments
Both earnest money deposits and down payments are financial commitments made by the buyer as part of a real estate deal—but what that money pays for may vary. To summarize, earnest money:
Shows a buyer’s commitment to the sale, although it’s not always necessary.
Is typically paid at the time of signing the sales contract/purchase agreement, and held in escrow until the deal closes.
Can be applied toward closing costs, including your down payment.
May be refundable if the sale falls through.
Must be paid before the sale can close.
Is paid directly to the seller.
Is channeled toward the purchase price of the property itself.
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