Earnest money deposits are much less than a down payment. They can range from 1% to 3% of the purchase price.
They are not the same
As soon as you find the home you want to buy, the next step is to put an offer on the house.
Even though there may be some back and forth during that process, as soon as the offer is accepted your realtor will immediately request money.
This payment, called earnest money, is the first of many financial steps you’ll take on your journey to homeownership.
But what exactly is earnest money, and why is it different than a down payment?
What is the difference between an earnest money and a down payment?
The difference between an earnest money deposit and a down payment is that an earnest money deposit is a refundable deposit made by a buyer to show that they are serious about purchasing a property.
While a down payment is a non-refundable deposit paid towards the mortgage you are applying for.
Earnest money deposits are typically a small percentage of the total purchase price, while down payments are typically a larger percentage.
A commitment versus a portion of sales price
Another word for earnest is committed, so think of the earnest money as a promise.
It’s a promise that the buyer will purchase the house under almost any circumstance.
There are a few factors in which the money could be returned as stipulated by the contract, but most of those have to do with the seller backing out of the agreement.
Generally speaking when the buyer writes that check, they’ll either buy the house or lose the earnest money.
The down payment is a larger lump sum that goes directly toward the payment of the house.
It can be as low as 3% in certain circumstances, but ideally is at least 20% of the purchase price to avoid paying an additional (PMI) private mortgage insurace.
Check out these different down payment options.
All about earnest money
Usually the earnest money amount is between 1% and 3% of the home’s price (the variation is based on the area).
In certain circumstances or in certain geographical regions more money might be required. It’s possible that the seller will require more, but the buyer can also reject or negotiate that amount if it seems too high.
Often the earnest money is written as a personal check, certified check or paid by wire transfer.
Related: Earnest Money Requirements
Earnest money benefits to the seller
The earnest money benefits the seller because they’re taking their home off the market on the assumption that it will be sold.
By promising to buy it, the buyer is preventing other possible buyers from submitting purchase offers.
If the sale goes through as planned, then the earnest money is typically applied to the down payment. If the sale falls through, the earnest money is returned to the buyer.
In some cases, the seller may keep the earnest money if the buyer backs out for a reason that is not included in their contract (such as failing to get financing).
What happens to earnest money
When the buyer writes the earnest money check, it’s usually held by a third party like escrow or an attorney until closing day.
The money is held in escrow during that time. If the buyer walks away from the deal then the seller will usually receive the money.
There are certain circumstances in which the buyer can walk away without losing earnest money.
If major issues arise during the home inspection that weren’t listed in a disclosure document when the home was on the market, if the buyer has problems with financing or if there’s an issue with the land survey, or inspections then the buyer can usually walk away without losing the money as long as it meets the requirements of the purchase contract.
There might be other contingencies listed in the offer, such as the buyer needing to sell their own house within a certain timeline, that would allow the buyer to walk away from the sale and still retain their earnest money.
Why would a buyer walk away from the sale?
The most common reason a home buyer will withdraw from a sale is due to the buyer not being able to get financing.
Other reasons might include:
- The property doesn’t appraise for the sale price and the buyer is unwilling to pay the difference.
- The buyer is unable to provide proof of income or employment for the home loan
- The buyer has a change of heart and decides not to purchase the property.
- The seller backs out of the sale.
- The buyer is unable to provide a down payment or come up with the closing costs
- The buyer is not able to get insurance for the property.
- The buyer is not able to get homeowners association approval
- There are too many repairs needed on the property.
- The title search reveals problems with the property title.
- The loan terms are not favorable to the buyer.
What happens to earnest money if the seller cancels?
If the seller cancels the sales of the home for any reason, then the earnest money is returned to the buyer but the buyer might also be able to take legal action.
If the buyer doesn’t walk away, the earnest money either goes toward the down payment and closing costs, or the check is returned to the buyer.
In all likelihood the check will be deposited at some point, so don’t write an earnest money check without having funds to cover it at any time.
The buyer will know before closing if the earnest money check will be put toward the down payments and closing costs so that they’ll know the amount of wire to bring to closing.
All about the down payment
The down payment is paid in the last stage of the home buying process.
It goes directly to the seller even if that payment is through the lender.
The down payment can be as low as 3% of the home’s purchase price.
This money is a base amount to purchase the home.
The remainder of the purchase price after the down payment is often covered by a lender, which could be a bank or financial institution that is providing a mortgage to the buyer
The down payment should be brought to closing and usually in the form of a cashiers check or a wire. Check with your escrow or title company on their cash to close requirements.
They’re also not so different
Even though they have different names, both earnest money and down payment go towards the large price tag associated with buying a home. They’re just paid during different parts of the process.
They’re also big sums of money representing a percentage of the home’s purchase price.
It may even help to think of the earnest money as being part of the down payment.
In the end, both go towards the purchase of your home.
Buying a home is an investment and whatever money is put towards it; be it earnest money or the down payment – ideally you’ll get back someday when you sell your home.
The bottom line
The biggest thing to remember is that the earnest money is the first big check you’ll write when buying a home.
Make sure you are financially prepared for it so that you will have the money at hand when you’re ready to make an offer on a house.
The down payment is an even bigger financial commitment, but both the earnest money and down payment are necessary steps in chipping away at that price of a home.
With a larger down payment, a buyer can have a smaller monthly mortgage payment or have a shorter length of time in which to repay the mortgage.
Both earnest money and the down payment are big moments in the final steps to owning a house. Make sure you’re financially prepared when it’s time for these steps.
Types of loans that Coole Home can help you with:
- Conventional Loan – A loan option if you have a solid credit score. Sellers and realtors prefer this type of loan over any of the government programs that are available.
- FHA loan – A popular home loan for first time home buyers due to it’s lenient guidelines and low down payment of 3.5%
- VA home loan – perfect for veterans and active duty military members. Easy to qualify for and no down payment required.
- Jumbo Loan – A mortgage program used to finance properties that are too expensive for a conventional conforming loan.
- Bank Statement program– Great for borrowers who don’t want to provide their tax return for income quafifciation.
Don’t have a down payment? Home Loans with NO Down Payment
More info that may interest you:
- What’s the First Step in Buying a House
- How to Buy a Home for the First Time: A Guide
- Earnest Money – What is Earnest Money and is it Required?
- How to save for a down payment
- Are property taxes included in the mortgage?
- Property Taxes
- What are the 4 c’s of credit?
- What is an appraisal contingency?
- Flying Solo: Purchasing a Home Without Your Spouse in Texas
- The Real Reason Underwriters Deny Loans – What You Need to Know
- Stretch Your Home Buying Budget with a 40-Year Mortgage
- Save Money on Your Mortgage with a No Closing Cost Option
- Co-Borrowers on a Mortgage: Everything You Need to Know
- Maximize Your Home Buying Budget: Lender Credits 101