As a home buyer, you may be wondering what the difference is between earnest money vs. down payment. Both are important parts of the home-buying process, but they serve different purposes. Keep reading to learn more so you can be prepared when it comes time to buy your new home.
What is Earnest Money?
When purchasing a new home, prospective homeowners must provide earnest money to show their commitment to the purchase. Earnest money is a deposit made with the seller when making an offer on a new home – usually in the amount of 1 to 3% of the purchase price. The funds are typically held in escrow until closing, and if all goes according to plan, the funds are credited toward the total purchase at closing.
Where the earnest money is held is defined in the terms of the purchase agreement. Typically, funds are held in escrow by your real estate agent or by the firm that handles the closing. The funds are refundable in certain circumstances but may be forfeited to the seller if certain criteria are not met. Look to your real estate agent for guidance so you fully understand the terms before you submit earnest money.
What is a Down Payment?
A down payment is also required for most mortgage financing and represents a portion of the total cost of a property that must be paid upfront. The down payment size varies but tends to be 3-25% of the home’s purchase price. Keep in mind the type of loan you choose to finance the purchase of the home, will impact the amount of the down payment required. Although these two payments may seem overwhelming, they represent stability and assurance that important financial responsibilities are taken seriously by both parties involved in the transaction. Your lender can provide guidance regarding the amount you will need to put down as well as the source of down payment funds.
Tips on how to save for earnest money and a down payment
Saving for a down payment or earnest money can seem daunting at first, especially when you think of the amount needed. However, there are a few steps you can take to effectively save up while still maintaining your current lifestyle. Start by budgeting your income and assigning specific amounts to each category, including your savings goal. Put any extra funds into a separate account designated for down payment savings only. Additionally, look for creative ways to cut down on spending; consider cutting back on eating out, reducing paid subscriptions, carrying your lunch to work, or making coffee at home rather than buying from your local café. It may seem like a small amount but it can add up quickly! Finally, make sure to take full advantage of any applicable employer matching programs or tax advantages such as an IRA. Putting all these practices in motion will help ensure that you reach your savings goal in no time!
When you would use earnest money over a down payment
Earnest money creates a sense of security and commitment from the buyer to a potential property purchase. This “good faith deposit” is an important part of many real estate transactions, as it signals both the buyer’s intent to follow through on buying the home and their confidence in closing the deal. Typically, earnest money deposits are more prevalent in higher-priced transactions. For example, when entering into a contract with a builder for new construction or extensively remodeling the property, buyers will likely be legally obligated to provide earnest money as part of their down payment. Additionally, hot market properties or multiple offers can also require an earnest money deposit before the seller will accept your offer. By providing additional earnest money instead of using your down payment towards the purchase, you can demonstrate sincere commitment while also hedging against any issues that may arise during a closing.
When you’re ready to buy a home, you must understand the difference between earnest money and a down payment. While both are used to show sellers that you’re invested in purchasing their property, they serve different purposes. Earnest money is used in good faith to seal the deal while a down payment secures your interest in the home and is applied toward your mortgage. Saving for these two items can be difficult, but there are plenty of ways to cut costs and make room in your budget. By understanding when to use each one, you can confidently put an offer on your dream home.
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Richard has extensive experience in all aspects of buying and selling residential property. He has sold more than 400 homes and well over $100 million in residential real estate. There’s no need to guess. Get expert advice that will allow you to buy and sell with confidence and ease.
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