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What Is The Difference Between An Earnest Money Deposit And A Down Payment?

Buying a house is an exciting and rewarding life event. But going through the buying process is not. Not only is this a stressful time, but it can be quite expensive, too. There are lots of fees and charges that you need to pay in order to finalize the purchase. Two of the terms that you will encounter when closing your home are ‘earnest money deposit’ and ‘down payment.’ 

Does earnest money go towards down payment? What is the difference between the two?

In this guide, you will find the answers to this question so you can go into the process more informed and ready to tackle the job at hand. 

What is the Earnest Money Deposit?

So, you have found the perfect home that you want to buy. In order for you to begin the purchase process, you need to pay cash for it – it’s called the earnest money deposit. 

This initial payment is made before signing the purchase contract for the home is completed and implies to the seller that you are serious about making a purchase. Once the two parties agree on the contract, the seller is obligated to take the property off the market. This means that the buyer has the right to purchase the home and the seller cannot accept any other offers. 

But there is a risk involved here; the seller can experience major inconvenience and financial loss in the event that the buyer changes their mind or opts for another home. For this reason, an earnest money deposit is required in order to protect the seller from any financial loss and to keep buyers from wasting their time. The earnest money deposit is for them to take in the event that the contract is broken by the buyer.

The cost of the earnest money deposit can be 1-3% of the overall cost of buying the home. However, this can vary significantly based on a variety of factors, such as the location of the home, the existing conditions in the real estate market, and whether the home is brand new or a resell.

For example, in a slow market, you can negotiate for a lower earnest money deposit. But in a hot market, some buyers are willing to pay more for the earnest money deposit in order to keep the seller from getting offers from other prospective buyers. 

When dealing with a brand-new home build, the circumstances governing the earnest money deposit are a bit different. The builder might require a higher earnest money deposit, which usually starts at 5% of the cost of the home construction. If the buyer has any specific requests during the build, this can cause the deposit amount to further increase – up to 25% of the total home cost. 

Is an Earnest Money Deposit Refundable

Is an Earnest Money Deposit Refundable?

It depends. You need to include this as a clause in your earnest money deposit contract with the seller. There are certain circumstances when an earnest money deposit is refunded to the buyer.

One such circumstance is when there are issues found in the home during inspection. The buyer has the right to cancel the earnest money deposit and have it refunded, especially if the home seller is unable to fix those issues within an agreed period of time. 

Another instance when you can ask for the earnest money deposit to be refunded is when the actual appraisal of the home is lower than the initially discussed purchase price. You can either request a price reduction or have it fully refunded. 

What is a Down Payment?

A down payment is another common financial term that you will encounter when dealing with a home purchase. This is the amount of money that must be paid towards the purchase of the home. The total amount to be paid for down payment will be percentage-based. The more expensive the home is, the higher the down payment you need.

The down payment is established at the start of the application process, if you are applying for a loan. The cost of the down payment will be different from one lender to another, although the typical percentage starts at 3.5%. Other factors can also impact the percentage of the required down payment, such as your credit score and the length of the loan term. 

Some lenders do allow you to put in a higher down payment than what is required during application. This is a step that you can take to increase your chances of being approved for the loan. 

Earnest Money versus Down Payment What's the Difference

Does Earnest Money Go Towards the Down Payment?

Yes. Any amount you pay as an earnest money deposit will be applied to the down payment for the home purchase. It can also be used to offset any costs involved with closing the home purchase. 

It will not be deducted from the total cost of the home purchase. 

Earnest Money Deposit vs Down Payment

As you can see, there is a significant difference between these two. and they should not be confused as the same. In its most basic form, the earnest money deposit is given to the seller to show them that you are serious about buying the home. On the other hand, the down payment is paid to the lender in order to increase your chances of being approved for the loan. The down payment also shows the lender that you are serious about pursuing the loan since you have paid them a substantial amount of cash. 

This is important information for would-be home buyers to learn so that you can allocate enough cash for the payment of each. 

It is also important to take note that since these fees are percentage-based, there is no fixed amount. It will be based on the actual appraisal value of the home upon the signing of the contract. 

When it comes to the negotiation of the earnest money deposit, it is important that you consider all possible scenarios that will give you the right to cancel or ask for a refund. This will ensure that your rights are also protected during the buying process, and prevent any significant financial loss in the event that the contract does not go through. 

 

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