Earnest Money vs. Down Payment: What’s the Difference?
You worked hard, saved your money, and now you are ready to buy a house. If you’ve done your research, you probably know that you’ll need a down payment for a home purchase. The amount of your down payment will vary depending on your home loan program, the purchase price and your credit score.
But while you might anticipate this expense, you might not expect to fork over money for a down payment until closing day. So being told to include an earnest money deposit with a home offer might take you by surprise.
Although many homebuyers are aware of down payment and closing costs requirements, some aren’t too familiar with earnest money deposits. If you’re thinking about buying a house, it’s important to understand what this deposit is and how it differs from the down payment.
What is an Earnest Money Deposit?
A home seller may receive multiple offers on their property. When reviewing and considering these various offers, they want to make sure that they work with a serious bidder. For this reason, it is customary for homebuyers to include an earnest money deposit with their purchase offer.
This is essentially good faith money and indicates that you’re a serious buyer with a strong interest in the property. You’ll include a check for the earnest money with your offer, but the money isn’t touched until the seller accepts your purchase offer.
At this point, the earnest money is placed in an escrow account and applied to your down payment.
Earnest money deposits are much less than a down payment. They can range from 1 percent to 2 percent of the purchase price. In some states, however, an earnest money deposit of $500 or $1,000 is acceptable regardless of the purchase price.
This deposit protects the seller. If you agree to a purchase and later back out of the deal, the seller can keep your deposit.
What is a Down Payment?
As mentioned, earnest money is deposited into an escrow account and applied to your down payment.
Down payment percentages are higher than earnest money deposits. The amount of your down payment can range from 3.5% to 5% (or more) depending on whether you choose an FHA home loan or a conventional home loan, respectively.
Some first-time homebuyer programs, however, require as little as 3% down. If you have a credit score lower than 579 and you’re using an FHA home loan, you’re required to put down at least 10%.
Down payments are paid at closing by wire transfer or certified check, and most mortgage loans require a down payment as a condition for approval. The exception is zero down loan products such as VA and USDA.
Because you’re paying a percentage of the home’s purchase price upfront, a down payment reduces how much you need to finance. As a result, you end up borrowing less money than the purchase price. Therefore, the bigger your down payment, the smaller your monthly mortgage payment.
Buying a home is a big financial investment, so there are numerous costs associated with a house purchase. Speak with one of our loan experts if you have any questions about earnest money deposits, down payment and/or closing costs.
Cherry Creek Mortgage is here to guide you through this process and make your home buying experience a positive one. We also offer a variety of mortgage programs, whether you’re looking to purchase or refinance. We’re eager to help you find the right program for your situation.