What is the Difference Between Earnest Money and Down Payment?

When looking to purchase a home, you might encounter terms that you are not familiar with that may cause confusion. Two of the terms that you may be unfamiliar with and that may confuse you are earnest money and down payment. While both are financial contributions you need to make as a buyer, the two serve different purposes and play distinct roles in the real estate transaction process. It is crucial that you understand the difference between “earnest money” and “down payment.” Below, we look at earnest money vs. down payment.

Understanding Earnest Money

Earnest money is paid into an escrow account after the seller accepts your offer. Earnest money essentially shows your good faith, signaling your commitment to the transaction. It shows you are serious about buying the home. Earnest money provides the seller with some form of assurance that you will not back out of the deal without a valid reason. Typically, earnest money is a small percentage of the purchase price, usually ranging between 1% and 3%. However, it can vary depending on the area and the specifics of the deal.

Earnest money may be refundable under certain circumstances. For example, when contingencies such as financing, inspection, or appraisal are not met, earnest money can be refunded. However, if, for example, you simply change your mind, you may not be entitled to get your earnest money back. The seller may be entitled to keep the money as compensation for taking the property off the market.

Understanding Down Payment

A down payment, which is due at the time of closing, is a larger amount you pay directly to the seller. Lenders require home buyers to make down payments to secure a mortgage. Down payments can affect mortgage approval. Your down payment is a portion of the home’s purchase price, and the amount may vary depending on the loan type and your financial situation. However, lenders typically require buyers to make down payments of 3% of the home’s purchasing price. A down payment of 20% is common since it increases a buyer’s chances of having their mortgage approved and reduces monthly payments. If you make a down payment of less than 20%, you may be required to purchase private mortgage insurance (PMI). This type of insurance protects lenders in case of a loan default.

Differences Between Earnest Money and Down Payment

Earnest money and down payment are both payments you make as a buyer. However, there are several differences between the two. First, while earnest money shows your good faith, signaling your intent to follow through with the purchase, a down payment is a financial contribution that affects the size of your mortgage loan. Second, earnest money is a small percentage of the purchase price (usually between 1% and 3%), whereas the down payment is significantly larger. Third, while earnest money may be refundable under certain situations, such as if contingencies are not met, the down payment is non-refundable. Finally, earnest money is paid at the beginning of the transaction, while the down payment is made at closing.

Contact Us for Legal Help

If you have questions or need legal help, contact our experienced attorneys at SAC Attorneys LLP.