Earnest Money Deposit vs Down Payment: What's The Difference?
When you buy or sell a home, you get used to hearing words and acronyms you've never heard before. Your real estate agent, mortgage lender, escrow officer and the insurance agents who help you through the process will throw around so much real estate jargon, somewhere along the way you might wish you had brought a dictionary-or maybe a translator.
Two rather vague but very important terms for buyer and seller alike are "earnest money deposit or EMD" and "down payment." Both have to do with cold, hard cash, but what's the
difference? Here's your cheat sheet on earnest money deposit vs. down payment:
What is earnest money?
Earnest money—also known as an escrow deposit—is a dollar amount buyers put into an escrow account after a seller accepts their offer. Buyers do this to demonstrate to the seller that they're serious and are entering a real estate purchase with the intent of closing the transaction.
Another way to think of earnest money is as a good-faith deposit that will compensate the seller for liquidated damages if the buyer breaches the contract and fails to close.
How much is a typical earnest money check?
In California the earnest money deposit is typically 3% of the purchase price. For example, if the home sales price is $1,000,000 and the EMD is 3%, your deposit would be $30,000. This is also the limit of your liability should you breach your contract and have agreed to liquidated damages. However, the deposit may vary depending on your state and often is negotiable. Secondly, if you find yourself in a seller’s market and want your offer to garner more attention, you may want to consider increasing this deposit.
The earnest money deposit process
For California, in most cases the deposit is delivered directly to escrow within 3 days of an accepted offer. Today, the monies are most often delivered electronically, but can be made with cashier’s check, personal check or other.
The monies are typically held by escrow, or another third party (but never given directly to the seller) and sometimes check is not even cashed.
If the check is cashed, the funds are held in an escrow deposit account. The money will be shown as a credit to the buyer at closing and will offset part of the down payment amount and closing costs.
So, here's the real crux of the matter: If a prospective buyer backs out of the deal, the seller might be able to keep the earnest money deposit. But keep in mind that if the buyers back out for any reason allowed by the contract or purchase agreement, they are legally entitled to get their earnest money back.
What is a down payment?
A down payment is an amount of money a home buyer pays directly to a seller. Despite a common misconception, it is not paid to a lender. The rest of the home's purchase price comes from the mortgage.
The money you put down can come from the buyer's personal savings, the profit from the sale of a previous home, or a gift from a family member or benefactor.
Down payments are usually made in the form of a cashier's check and are brought to the closing of a home sale or wired directly from the buyer's bank.
Typical down payment amount
The exact amount of a down payment is often determined by the lender in relation to the overall loan amount and conditions. The minimum down payment required by mortgage lenders can be as low as 3% of the house's price. However, a 20% down payment is ideal and often recommended by real estate agents.
Your purchase offer will include how much money you intend to put down, and a seller may be more likely to accept your offer if you are making a larger down payment.
But that's not to say you must put down 20%. After all, that's a large chunk of change to have on hand, especially for first-time home buyers.
Be aware that the down payment is not all you need to buy a house. You also need to budget for closing costs, appraisals, and other expenses when you purchase real estate.
Is a 20% down payment mandatory?
For decades, a 20% down payment was considered the magic number you needed to be able to buy. It's an ideal amount, but for many people it's not realistic. In fact, many financing solutions exist, so you can consider that myth busted.
"Putting less than 20% down is acceptable to most lenders as long as your monthly debt to
income ratio falls within their requirements.
If you're putting down less than 20%, however, there's a catch. You will probably have to also pay for mortgage insurance, an extra monthly fee to mitigate the risk that you might default on your loan. And mortgage insurance can be pricey—about 1% of your whole loan, or $1,000 per year per $100,000. However, these rates vary, and it pays to shop around.
Still, nothing compares to the feeling of owning your own home, so if you have your heart set on buying, there are options out there to help you achieve your dream of homeownership.
