When purchasing a house, new home buyers sometimes confuse the earnest money deposit with the down payment. So, what is the difference between an earnest money deposit and a down payment? Let’s take a look.
Earnest Money Deposit
The earnest money deposit (EMD) is to indicate to the Seller that you, the Buyer, is serious (or earnest) about the offer you’re making on their house. Some Buyers offer insignificant amounts as an EMD, such as $500 or $1,000. However, that doesn’t impart an intense conviction on the Buyer’s part to making the deal happen.
During the escrow period, there are certain events and scenarios that will cause a Buyer to back out of the deal. In some cases, the Buyer gets the EMD back after cancelling, and in some cases, they forfeit it to the Seller. Therefore, the Buyer should have enough skin in the game to make them really want to go through with the deal, instead of backing out at the slightest obstacle.
How big is a typical earnest money deposit?
The EMD should be a large enough amount that the Buyer doesn’t want to risk losing it. Our office usually suggests a deposit of 1% of the offer amount. Some Buyers want to show that they’re REALLY interested, and they’ll offer more, but 1% is sufficient.
When is the earnest money deposit due?
Usually, a Buyer cuts an EMD check payable to the escrow company when making an offer. When that offer is accepted, the check is deposited into escrow and the escrow period begins. However, the Buyer legally has 3 days from acceptance of offer to get the check into escrow.
How much money should I put down on a house?
The down payment refers to the amount of cash you will be putting into the purchase. Unlike the EMD, the down payment has no effect on the Seller, but it is very important to the bank that’s making the loan.
The bank wants you to have a sizable amount of equity in the property in order to feel more confident about loaning you money. Typically, that means a down payment that is 20% of the purchase price. If your down payment is less than 20%, the bank requires private mortgage insurance (PMI), which raises your monthly mortgage payment.
Some products like USDA, and VA loans allow for low- to no-money down, but they have other restrictions, such as minimum income level, or military service requirements, which won’t work for everybody. Conversely, some Buyers make larger down payments, which gives them greater equity and allows them to borrow less.
When is the down payment due?
At close of escrow, the bank funds their promised loan amount, and you bring a cashier’s check made payable to the escrow company (this may vary by state). The escrow company divvies up the monies amongst the appropriate parties.
In a Nutshell
The earnest money deposit should be at least 1% of the purchase price, and be delivered via personal check or money order payable to the escrow company at the START of escrow.
The down payment ideally should be at least 20% of the purchase price (it can be more or less depending on the circumstances), and be delivered via cashier’s check or money order payable to the escrow company at the CLOSE of escrow.
Nikolas Allen is a Realtor® with J. Harris & Associates in Mt. Shasta, California. He helps people through the complex process of buying and selling their homes. He put less than 20% down on his house, and is currently paying for PMI.