Earnest money and down payments are two important concepts for homebuyers to understand when purchasing a home.
Though they sound similar and are both associated with buying ahome, there are some differences between putting money down and earnest money that buyers should know.
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Let’s dive into who the two separate payments are for and how Compass Mortgage can help you put together a competitive offer to purchase the home of your dreams.
What is earnest money?
Earnest money is a deposit paid to the seller by a potential homebuyer to show their seriousness and “good faith” in the purchase.
The deposit is paid after a buyer submits an offer on a home but before closing. The earnest money deposit is held in an escrow account until closing.
If the offer is accepted, the earnest money becomes part of the down payment at closing.
If the offer falls through, the earnest money is normally returned to the buyer unless the buyer is found to have breached the purchase contract, in which case it may remain with the seller.
Earnest money shows the seller that the buyer is serious about purchasing the home. It also provides some security to the seller in case the buyer backs out without a legitimate reason.
Earnest money deposits help both buyers and sellers
Earnest money benefits not only the seller.
If the deal falls through because of issues on the seller’s end (like failure to provide the property’s title), the earnest money is returned to the buyer. This provides some protection for the buyer’s interests as well.
Overall, earnest money helps facilitate the trust needed to complete a real estate transaction between buyer and seller.
How much is required for an earnest money deposit?
The typical earnest money amount is between 1-3% of the home’s purchase price (generally 3%), though it can vary depending on local norms and the home price.
For example, the earnest money deposit for a $300,000 home might be between $3,000 and $9,000.
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What is a down payment?
A down payment is the portion of a home’s purchase price that the buyer pays up front at closing. The down payment is the buyer’s initial equity stake in the home.
Common down payment amounts are 10-20% of the total purchase price, though first-time homebuyers can often put down as little as 3-5% with certain loan programs.
On a $300,000 home purchase, for example, a 10% down payment would be $30,000 due from the buyer at closing.
The down payment serves a few purposes. First, it immediately builds equity in the home for the buyer.
A down payment allows the buyer to immediately gain an ownership stake in the home rather than owing the full purchase price amount to the lender.
Second, down payments lower the loan amount needed, which reduces monthly payments and interest charges over the long run. Lower loan amounts also allow buyers to qualify for better interest rates from lenders, making their mortgages more affordable.
Down payments also signal to lenders that buyers have “skin in the game.” This reduced risk leads lenders to offer lower rates. Homebuyers with larger down payments tend to get better mortgage terms (specifically, a better interest rate along with reduced closing costs).
Key differences between earnest money and down payment
While earnest money and the down payment are both up-front payments associated with homebuying, they serve different purposes at different times in the process.
Differences include:
- Earnest money comes after making an offer, while the down payment comes at closing when purchasing the home.
- Earnest money acts as a good faith deposit and is typically 1-3% of home value. Down payments are usually larger.
- Earnest money is held in escrow until closing, while the down payment actually transfers ownership of the home from seller to buyer.
- Buyers can lose earnest money if they back out of a deal, but down payments always go toward equity in the home (for the buyer).
- Earnest money solidifies a buyer’s offer, while down payments secure financing terms and build immediate equity.
- Earnest money provides credibility early in the home buying process, while down payments make possible actual ownership and verify financing for the buyer. They work together to complete the property purchase transaction.
Understanding both these terms and the difference between them leads to a smoother homebuying process.
Be sure to discuss earnest money and down payment details with your real estate agent and lender when purchasing a home. They can provide greater insight on managing both effectively to buy your dream home!
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The experts at Compass Mortgage can guide you through the entire process—from pre-approval to closing.
In fact, Compass Mortgage goes above and beyond standard pre-approval with its unique Get Committed® program.
Structure the perfect offer with a fully underwritten loan commitment even before you find the right home when you Get Committed® with Compass Mortgage.
This loan commitment locks in your interest rate and shows sellers that you already have secured financing.
With competitive rates and proven solutions, we can help make your financial journey easy and efficient.
Apply with Compass Mortgage today to learn more about your options.
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Photo by Antoni Shkraba