What's the Difference Between an Earnest Money Deposit and a Down Payment?

When you put in an offer on a home, your REALTOR(R) will talk to you about your earnest money deposit. Your earnest money deposit is different from your down payment - in fact, it's an additional sum of money you have to come up with before you buy a home.

But what's the difference between an earnest money deposit and your down payment? And what happens to the cash?

Here's what you need to know.

What's the Difference Between an Earnest Money Deposit and a Down Payment?

An earnest money deposit is "good faith" money. It's a sum of cash you show a seller to let him or her know you're serious about buying a home. You don't get to keep it, though - at least not now. You "show" it to the seller by giving your real estate agent a cashier's check (to prove that you really have the funds). Your agent will then put that check into escrow with a third-party agency.

Your down payment is money you show the lender when you buy a home. That money gives the lender more faith in your willingness to repay the loan it's about to give you - it shows you have some skin in the game, so to speak.

What Happens to Earnest Money?

You never give earnest money directly to a seller. You give it to your agent, usually in the form of a cashier's check,  and your agent puts it in escrow. Escrow is for safekeeping of money and important documents during the transaction.

When you close the deal, your earnest money deposit usually goes toward your closing costs. However, in some situations, it can go toward your down payment. 

The seller doesn't actually get that money unless you back out of the deal without a valid reason. If you back out of a deal because you got cold feet, for example, you'll most likely forfeit your earnest money deposit to the seller. The seller then has to start from scratch by re-listing the home and finding a new buyer.

How Much is an Earnest Money Deposit?

You can expect to show the seller between 1 and 5 percent of the home's purchase price as an earnest money deposit. That figure varies based on the type of market, too. In a highly competitive market, you might have to put down 5 percent - or more - to incentivize the seller to take his or her home off the market.

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