Earnest Money vs Down Payment: What's the Difference?

If you’re in the market for a house, you’ve probably noticed several different payment types for purchasing a home. Two main forms are earnest money versus down payments. Learn about the similarities and differences between the two types of payments.

What is earnest money?

Earnest money is a deposit you can make to the seller when submitting an offer for a house. This deposit shows your interest in following through and can convince the seller to hold the property while you both work out the details of purchasing it. Depending on the agreement with the seller, you can choose to put down as much or almost as little as you want, but an earnest money deposit should only go as low as 1% of the home’s purchase price. Sellers don’t always request earnest money, but it can show the seller you’re serious about buying their property.

A third party company will hold the earnest money in an escrow account once the deposit is decided upon and submitted. You’ll need to meet conditions and finalize the sale for the money to be released. “If the offer is not accepted or if the transaction is canceled per the details agreed upon in the purchase agreement, this money is refunded,” said Michael Hausam, a real estate agent and home loan originator in Irvine, California. This is unless the parties agree that some portion should be used for cost incurred—but it’s rare.

What is a down payment?

A down payment is a lump sum paid at closing on the house. It’s based on a percentage of the agreed-upon purchase price of the property. Usually, about 20% of the purchase price is seen as a satisfactory down payment to put forward, but it can be as low as 3%. A higher down payment can mean lower mortgage payments later but don’t necessarily drain your funds trying to make it happen.

A down payment should be ready before closing on the house, and is usually a vital part of qualifying for a mortgage. Down payments essentially act as a safety buffer for the lender to ensure you can and will pay your mortgage. If you’re not getting a mortgage, you may not have to worry about a down payment, but you’ll still have to work out another payment method with the buyer.

Earnest money deposit vs. down payment

The biggest difference between earnest money and down payments is that a down payment is almost always required for a mortgage. While earnest money is usually expected regardless of how you plan to finance your home, earnest money isn’t always required. It is important to note that a generous earnest deposit will set a buyer apart from others and may convince a seller to hold the property for them.

While a down payment is almost always a large chunk of a house’s purchase price, earnest money is typically a smaller percentage of the cost of a house. If you think about how a down payment is required by most lenders, earnest money may help convince the seller that you’re a serious buyer.

An earnest payment is usually delivered up-front when an offer is accepted. Down payments are made at the closing of a property. Here’s where it can get a little confusing: Both payments technically go toward the home’s full price, but earnest money is part of the down payment. On the other hand, the down payment is never part of an earnest money deposit.

Does earnest money go toward the down payment?

If you offered a good chunk of money as your earnest money deposit, and now you’re looking at your down payment and sweating, don’t worry! Your earnest money deposit goes toward the down payment of the house and closing costs. Earnest money rarely covers all of a down payment, though.

“While earnest money is typically a portion of the total down payment, rarely does a buyer offer the entire down payment amount at the time of offer. I have seen this happen in some cases when the buyer wants to show strong interest,” said Lisa Gaffkin, a home loan specialist from Orange, California.

Does earnest money go toward closing costs?

In the case of having submitted an enormous earnest money deposit during the offer stage of the home buying process, the earnest money could exceed the percentage of the down payment and cover it and the closing cost of the property. On the other hand, even if your earnest money is small, it splits into both paying for part of the down payment and part of the closing costs.

Conclusion

Despite the similarities, an earnest payment is to show a seller you are serious about buying their property; it’s also paid upfront. On the day of closing, the earnest money is put toward the down payment of the house and possibly closing costs. It’s important to note that an earnest money deposit doesn’t need to be a high percentage of the house’s cost, it is still very wise to include it in your offer.

A down payment can be necessary to secure a loan and buy a house. The earnest money and down payment are based on a percentage of the home’s purchase price, but the down payment is important in showing your lender credibility. If you can afford it, going for a higher percentage on your down payment is better for you and your wallet in the long run.