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Real Estate

Earnest Money Vs. Down payment: What’s the Difference

Earnest Money Vs. Down payment: What's the Difference

If Millennials and Gen Z have anything to say about it, more and more people are seeking out their forever home during their first foray into the housing market.

This is a great way to make the most of an investment, but it also means home buyers with a lot of questions about how buying a house works. Starter homes may be a thing of the past. If you have questions about things like earnest money vs. a down payment, you’re not alone. Read on for information about all of the expenses to expect while buying a home!

What Is Earnest Money?

Earnest money, also known as a “good faith deposit,” is a specific amount of money that you add to your offer to buy a home that goes into an escrow account. Almost all purchase offers include earnest money in today’s real estate market. Earnest money isn’t required, but if you want your offer taken seriously, then you absolutely need to include it.

The reason for this is that sellers see it as a sign that you are making a serious offer on a home and you intend to follow through with it. Why does this matter? Once the seller accepts your offer and earnest money, they take their home off the market, so if the sale falls through, they have to start the process all over again.

If you’re planning on buying a home soon, plan on putting between 1 and 3 percent of the sale price down as earnest money. All markets are different, however, so talk to your realtor about how much you should put down.

Earnest Money vs. a Down Payment

Earnest money is not the same thing as a down payment.

A down payment is money that you pay at the time of closing toward the cost of the house. You pay this money directly to the lender, not the seller of the house. You can choose to put down anywhere between 0 and 30 percent of the cost of the house as a down payment.

Applicants for home loans in Australia who have at least 20 percent to put down may qualify for low doc home loans. If you’re in the US, having at least 20 percent to put down on the house increases your chances of approval and lowers your overall payment amount. It also helps you avoid having an insured mortgage.

An insured mortgage is a mortgage that includes insurance to protect the lender against default. Once your mortgage payments reach 20 percent of the purchase price of your home, then your lender stops making you pay an insurance payment.

Does Earnest Money Go Towards a Down Payment?

Yes, in most cases, your earnest money goes toward your down payment. The title or closing agent in charge of the escrow account for the sale of the house transfers the money from the escrow account to the mortgage lender. You then pay the remainder of your down payment at the time of closing.

The only time the earnest money doesn’t go toward your down payment is when the buyer backs out of the deal. When that happens, you forfeit that money to the seller. You may also owe damages to the realtor in the amount of their commission on the deal and other fees.

What If You Don’t Have Earnest Money?

Earnest money isn’t required, and there are some ways you can try to get around it. In your offer, request a waiver of earnest money. Make sure to work with an experienced real estate agent on this request to increase your chances of having your offer accepted.

If you’re struggling to get a seller to accept your offer, then it might be prudent to put your search on pause until you have enough money to put down in the form of earnest money.

How to Get Earnest Money Back

Many people find themselves worrying about how to get earnest money back if a deal falls through. There are definitely specific circumstances in which the buyer has the right to their earnest money back.

The first is when the buyer backs out of the sale of the house for a reason that falls within a contingency outlined in the sales agreement. For example, you can make an offer that specifies that the house must pass a home inspection. If the home inspection comes back with major issues, you can use that contingency to back out of the sale and get your earnest money back.

You also get your earnest money back when the seller of the home backs out of the deal, regardless of the reason. In that instance, you’ll receive the earnest money in the same form you received it.

Other Expenses to Expect

Buying a home comes with no shortage of expenses that you have to pay long before the keys are in your hands. The first expense to plan for is a home inspection. This is a minor cost, but it’s a critical aspect of every home purchase to ensure that you’re buying a quality home.

One of the larger expenses to plan for is closing costs. Depending on how you work out the sale, you may be able to have the seller cover closing, but regardless of how the sale is structured, they must be paid. Closing costs include things like loan fees, legal fees, HOA fees, or property taxes.

Are You In the Market for a New Home?

When it comes to the question of earnest money vs. a down payment, they’re both sums of money you have to pay before you close on a house. The timing and their amounts are different, however. If you’re thinking of hitting the real estate market, be sure to do your research about your overall budget and the amount of cash you’ll need on hand to buy your dream home!

Managing life as a homeowner is not always easy. You’re bound to have questions from time to time. Be sure to check out our blog for tons of great tips for new and experienced homeowners alike!

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