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Earnest money vs. down payment: what’s the difference?

On Behalf of | May 22, 2024 | Real Estate Law |

When purchasing a home, you’ll encounter the terms earnest money and down payment. Both involve a financial commitment, and they serve distinct roles in the transaction process.

Earnest money

Earnest money is often referred to as a “good faith deposit.” It demonstrates to the seller that you are serious about purchasing their property. This deposit usually ranges from 1% to 3% of the home’s purchase price. Upon acceptance of your offer, the earnest money stays in an escrow account until the closing of the sale.

If the transaction falls through due to contingencies, such as a failed inspection or financing issues, you may receive a refund of your earnest money. However, if you back out of the deal without a valid reason, the seller typically retains the deposit as compensation for taking the property off the market.

Down payment

A down payment is the portion of the home’s purchase price that you pay upfront at the closing. This payment directly reduces the amount of money you need to borrow through a mortgage. This signifies to lenders that you are financially stable and committed to the investment, thereby reducing the lender’s risk.

Down payments generally range from 3% to 20% of the purchase price. A larger down payment can improve your loan terms and reduce your monthly mortgage payments.

While both earnest money and down payment involve upfront costs in buying a home, they serve different purposes. Understanding the distinction between these two can help you navigate the home-buying process smoothly and make informed financial decisions.