What’s the difference between a down payment and earnest money?

On Behalf of | Jan 24, 2022 | Residential Real Estate Transactions |

Buying a house is a huge step in your life, and you don’t want to make any mistakes. The home buying process itself can be very confusing. It seems to have its own rules and language, and that can leave you on unfamiliar ground.

One of the first things you need to learn is the difference between your down payment and your earnest money.

Earnest money represents your commitment to the purchase

You’ve probably already had to pull together thousands of dollars for a down payment on the house of your dreams just to secure the financing you need – but you did it. You’re even preapproved for a loan.

Why, then, do you need to pull to come up with a few thousand more to hand over to the seller with your bid on their home? That’s called your “earnest money.”

Your earnest money is both a show of good faith on your part – showing that your offer is sincere – and an enticement to get the buyer to choose your offer over any others they may receive on the property. It’s usually 1% to 10% of the purchase price of the home, although a bigger payment is possible.

A healthy earnest money payment shows that you have the funds necessary to buy the home, and that makes the seller more confident in you as a buyer. No seller wants to have to put their home back on the market after they think they have a deal.

Your earnest money goes into escrow until closing, at which point it becomes part of your down payment on the home. Should you back out of the deal before it closes for some reason that isn’t permitted in your contract (for example, if the house fails its inspection), the seller can keep the earnest money. In this respect, your earnest money acts as a surety or guarantee that you’ll keep your end of the deal – if only because you don’t want to lose all cash.

When your homeownership dreams are almost within your grasp, make sure that you have experienced guidance along the way.