Down Payment vs. Earnest Money Deposit: The Differences
As a first-time homebuyer, things can get confusing really quickly. There are so many new terms and things to understand. A good place to start is with the terms down payment and earnest money deposit.
These are two common terms you will hear when you go through the process of buying a home in Madison. Let's look a bit closer to gain a full understanding of what a down payment is and what an earnest money deposit is.
What's a Down Payment?
When you buy a home, you will likely take out a mortgage. The money you pay directly to the seller isn't financed and is known as a down payment.
You will deliver the down payment to an escrow company and they will deliver it to the seller after closing. This money can come from your savings account, the proceeds from selling a current home, or many other sources. It's usually paid at closing via bank transfer or cashier's check.
Typically, you will need to put down at least 3% of the purchase price. If your down payment is 20% of the purchase price of the home or higher, you will avoid paying for private mortgage insurance.
The amount of your down payment will be determined by the lender. Your credit score, debt-to-income ratio, and other factors will be used to figure out how much money you will need to put down when buying a home.
What is the Earnest Money Deposit?
When you make an offer on a home, you will include an earnest money deposit. This money is used to help convince the seller you are serious about buying the home. A higher earnest money deposit can help your offer stand out if the seller receives multiple offers on the property.
For the seller, the earnest money deposit allows them to take them home off the market. They will feel confident the deal will close if the buyer includes a large enough earnest money deposit. If the buyer pulls out of the deal, the seller keeps the earnest money deposit, in some circumstances.
The amount offered for earnest money depends on what you feel comfortable with. It's common to offer around 3% of the purchase price of the home, but you can offer more or less.
How the Down Payment and Earnest Money Deposit Work Together
When a buyer makes an offer and the seller accepts it, a purchase agreement is signed. The earnest money deposit is paid at this time, based on the offer made by the buyer and accepted by the seller.
The money will be held by an escrow company until the deal closes. When the deal closes, the earnest money deposit is credited towards the down payment or towards closing fees.
If you're a first-time homebuyer, you want to make sure you provide a large enough earnest money deposit to be taken seriously by the seller. Your real estate agent will be able to help you choose the right amount when you make an offer on a home.