Earnest money vs. down payment: Exploring the differences

If you’re on the hunt for a home, one of the options you may encounter when putting in an offer is earnest money. Earnest money is a sum of money you put down to demonstrate that you’re serious about buying a home. But how is this different than a down payment? Let’s learn more about earnest money vs. down payments.

What is earnest money?

Earnest money is the money you put down before closing on a house. It’s sometimes also referred to as a good faith deposit and is usually around 1%-3% of the sale price and held in an escrow account until your purchase is complete. The exact amount of money may, of course, vary depending on your specific market.

In addition to signaling your interest in the home, earnest money provides extra security for the seller, as it helps them avoid a financial hit if the buyer backs out before closing. Depending on your agreement, it’s also possible that the earnest money is returned to the buyer if the deal falls through on the seller’s side.

A key feature of an earnest money deposit is that it goes toward your down payment and closing costs once the sale goes through — so it's not an additional cost in a successful sale. However, the seller gets to keep the deposit if the buyer backs out of the deal for reasons not included in the agreed-upon contingencies.

Why offer earnest money

There are a few reasons why you may want to offer earnest money when you’re purchasing a home:

• Show lenders you’re serious about purchasing the home
• Increase your chances of a successful offer
• Protect the seller in case the deal falls through

While putting down a deposit on a home may sound a lot like a down payment, there are some key differences you should be aware of when it comes to earnest money vs. down payments.

Earnest money vs. down payment

As a refresher, a down payment is the money paid upfront when making large purchases, such as a home. Generally, this is the portion of the purchase price that the buyer pays for in cash, while the rest of the cost is financed. Higher down payments can reduce the overall loan amount, which also helps reduce the amount of interest paid over the length of the loan. Some of the key differences between earnest money and down payments are as follows:

Earnest money:

• Is a deposit made by the buyer to show their good faith in a transaction.
• Typically ranges from 1-3% of the purchase price.
• Shows the seller that the buyer is committed to the purchase.
• Can help protect the seller in case the buyer backs out of the sale without a valid reason.
• Held in escrow until the sale is finalized.

Down payment:

• Is a percentage of the total purchase price that the buyer pays at closing.
• Typically ranges from 3-20% of the purchase price.
• Goes towards the overall cost of the home.
• May help to secure a lower interest rate and monthly mortgage payments.
• May be required by the lender as part of the mortgage approval process.
• Could represent a significant financial commitment for the buyer.

One of the most noteworthy differences is the cost — down payments are typically a good deal larger than earnest money deposits. Additionally, the down payment is part of the final purchase cost, while earnest money deposits are paid before closing and then applied toward closing costs or your down payment after the deal is completed.

Does earnest money go towards your down payment?

Yes, earnest money can potentially go toward your down payment. After agreeing to a purchase in writing with the seller, your earnest money deposit will be held in an escrow account until the deal is completed and you close on your home. Once that happens, your earnest money deposit is “refunded” to you by going toward your final closing costs, including your down payment.

In summary

Buying a home is a big purchase, so it’s important to understand the difference between earnest money vs. a down payment. Earnest money is a deposit you put forward with your offer to show the seller you’re serious. That money is then held in an escrow account until you close, at which point it goes toward closing costs.

Earnest money may, in certain circumstances, be refunded to the buyer in case a deal falls through on the seller’s end or, alternatively, offer the seller some financial relief if they need to relist the property after the buyer backs out.

A down payment, on the other hand, is typically a much larger, non-refundable percentage of the purchase, paid at closing and going toward the overall cost of a home. For specific information or for more guidance, talk to a home lending expert.