Navigating the world of real estate can be tricky whether you’re searching for your first home or preparing to put your house on the market. Going through the closing process can be time-consuming and stressful for both parties, especially when it comes to payment types. So, when it comes to earnest money deposit vs down payment: what’s the difference between the two?
What is Earnest Money?
An earnest money deposit, also known as a good faith deposit, is a payment made in conjunction with an offer to show the seller that a prospective buyer is serious about moving forward in the transaction. Earnest money deposits typically range from 1% to 3% of the home’s purchase price but can go as high as 10% depending on the market and location.
Earnest money allows buyers to continue additional steps such as mortgage financing, home inspections, and appraisals. The deposit will be held in escrow or with the title company until closing. If the process is completed without any issues, the deposit will be transferred from the account and be applied as a credit to the buyer’s closing costs and down payment. In some instances, the earnest money deposit may be refunded to the buyer, we explain the scenarios where this is the case in our blog, “Is Earnest Money Refundable?”
Down Payments Explained
A down payment is the required amount of money that is put towards the purchase of the property. Normally calculated based on a percentage of the total sales price, the amount will be established during the mortgage loan application process with your lender. The remaining percentage of the home’s purchase price is usually financed unless the buyer is making an all-cash purchase in which the remaining balance will be paid at closing.
The amount of down payment can vary, typically from 3% to upwards of 20% or more, depending on the type of loan.
- Conventional Loans require a minimum of 3% but it is common to put down 20%. A 20% down payment offers many benefits for the buyer as it will eliminate the need for private mortgage insurance, lower the monthly payment, and decrease the interest rate on their mortgage.
- Federal Housing Administration (FHA) Loans require a 3.5% down payment. FHA loans will have an additional mortgage insurance premium in addition to monthly payments.
- Veterans Administration Loans are available for active or retired members of the military. VA loans do not require a down payment or mortgage insurance.
Earnest Money Deposit vs Down Payment: Final Thoughts
While different, both earnest money and down payments are crucial parts of the buying and selling process. An earnest money deposit will show the seller that you’re not only serious about the purchase, but also want to move forward. The earnest money will be applied toward the down payment and closing costs during closing. The buyer’s down payment will finalize the sale and allow for the lender to approve the loan on the home. In simplest terms, earnest money shows a promise to the seller and a down payment shows commitment to the lender.
When it comes to an earnest money deposit vs down payment, knowing the difference between the two is key. If you still have unanswered questions regarding earnest money deposits and down payments, our team at Metropolitan Title is here to help. Contact us today.