Here’s the difference between earnest money deposits and down payments.
Every industry has its own terminology, which can often be confusing for those not in the know. Real estate is no different. However, conflating two different financial requirements can cause major problems during a transaction. What’s the difference between an earnest money deposit and a down payment?
Sometimes referred to as ‘good faith money’ or even a ‘binder’ deposit, the earnest money deposit is simply money set aside by the buyer to demonstrate to the seller that they’re serious. By purposefully putting some of their skin in the game, the buyer shows that they’re committed to getting the deal done.
As far as the state of Florida is concerned, a contract must have what’s known as ‘consideration’ to be deemed complete. That’s the role this earnest money deposit plays—it’s the consideration in the deal. Rather than going straight to the seller’s pocket, this deposit is typically held by a title company, an attorney, or sometimes a real estate brokerage involved in the deal. If the buyer exits the deal for a contractual reason (e.g., an inspection or financing contingency), then they will receive their earnest money back. Conversely, if the buyer decides to back out of the deal for a non-contractually protected reason, then the seller gets to keep the earnest money.
The down payment, on the other hand, is the buyer’s way to demonstrate their seriousness to the lender who’s financing their purchase. (If there’s no lender involved, then there’s no down payment). The down payment is the difference between the purchase price of the home and the amount of money the buyer is borrowing from the lender. For example, if you’re buying a home worth $1 million, but you’re only borrowing $800,000, then you’d have a $200,000 down payment.
Okay, so here’s one of the slightly confusing parts: The earnest money that’s being held by a third party gets rolled into the total down payment amount at closing. They’re coordinated, but they still serve different purposes.
Another distinguishing factor is that the down payment amount can differ depending on the type of loan being used. A VA loan, for example, is 100% financing, meaning there’s a 0% down payment. An FHA loan typically requires a 3.5% down payment, while conventional loan requirements generally range from 5% to 20%. Your down payment represents the initial equity you have in your house when you purchase it.
I hope you found this video to be helpful. As always, if you have questions about this or any other real estate topic, don’t hesitate to reach out via phone or email. We’d be happy to chat with you about your buying, selling, or investing needs, as well.