Understanding Earnest Money and Down Payment in Home Purchases

When you are looking to purchase a home, it is crucial to understand the difference between an earnest money deposit and a down payment. These terms are often confusing, and it's important to clarify the differences to avoid any potential issues during the home buying process.

What is an Earnest Money Deposit?

A earnest money deposit is a good faith payment made to the seller's agent, typically through an escrow service, to show your intent to purchase the property. This deposit is not the same as the down payment. It is used to secure your offer and holds the property while you negotiate and finalize the sale.

This deposit is non-refundable unless there is a specified contingency in the purchase agreement that is not met. For example, if the home inspection reveals significant problems that were not expected, the deposit might be returned to you. However, if you are unable to secure a loan, this is typically not one of the contingencies that would allow you to get your deposit back.

What is a Down Payment?

A down payment is a portion of the purchase price that you pay at the closing of the sale. It is the money that you contribute along with the mortgage to cover the full cost of the property. You cannot make a down payment until you have successfully obtained a mortgage loan and the loan is approved. The down payment is tied to the closing process and is included in the settlement statement.

How Earnest Money Deposit Relates to Down Payment in Home Purchase

Often, you might need to make an earnest money deposit before you apply for a mortgage. This deposit acts as a placeholder and is usually returned to you if the mortgage is not approved. In cases where the terms of the contract are unclear, it is common for the earnest money to be treated as a down payment. However, the contract itself should specify what happens if the loan does not go through.

It is important to note that the earnest money deposit is not the same as the down payment. The earnest money is non-refundable under most circumstances, while the down payment is only made after the mortgage is approved.

Multiple Contingencies in the Purchase Agreement

Many residential purchase agreements contain multiple contingencies. The most important of these is the loan contingency. This section of the agreement states that if the financing does not go through, the buyer is allowed to walk away and get their deposit back. These contingencies typically have a specific deadline, usually 17 days, by which they must be removed.

If the financing falls through, the buyer has the right to cancel the deal and get their earnest money deposit back. However, if the buyer removes the inspection contingency too early and the financing falls through, they could lose their deposit. This is why it is crucial to ensure your financing is fully approved before removing any contingencies.

Final Thoughts

Understanding the differences between an earnest money deposit and a down payment is essential when buying a home. The earnest money is a non-refundable amount placed to show good faith, while the down payment is the money you contribute at closing. Both are important parts of the home buying process, but they serve different purposes. By knowing the specifics of your contract and the contingencies involved, you can avoid any potential pitfalls and ensure a smooth transaction.