Earnest Money vs. Down Payment - What is the Difference?

When buying a home there is a whole lot of new terminology to learn. As a Realtor, I understand that I use real estate jargon often and have to remember that many clients may not know what I am talking about! Two terms that I notice are often misunderstood are "earnest money" and "down payment."

What is earnest money?

Earnest money, or good faith money, is the dollar amount buyers put into an escrow account after the seller accepts the offer. Buyers put this money down to show the seller that they are offering this money in good faith or to show commitment to finalizing the deal. This money is held, by a third party, in trust, until all conditions for the release have been met. Conditions for release of these funds include completion of inspections, completion of due diligence, or the buyer's ability to procure financing. The terms of the purchase agreement will determine whether the earnest money is refunded to the purchaser or retained by the seller. If the purchaser is unable to fulfil certain contractual obligations, then the seller usually is able to keep the funds. However, the buyer is also protected and can get the funds back if the seller terminates the contract or inspections or due diligence produces a failing event. It is very important to read your purchase agreement/ contract before signing so that earnest money is laid out and you understand exactly what you are signing.

How much is earnest money?

Earnest money deposits vary but are usually around 1 to 2% of the purchase price of a home. This often depends on your state and depends on the housing market. In some areas, 10% is required for earnest money! Remember earnest money is always negotiable so talk with your agent and let them know what you are comfortable with and they can tell you the pros and cons.

What is a down payment?

The down payment is an upfront cash payment that is typically a percentage of the total cost of the home. The average down payment for a house in South Carolina ranges from 3.5% to 20%. This is often depending upon what your lender states as the minimum or maximum in order to qualify for a mortgage. Often the down payment is the remainder that buyers have to pay out of pocket to complete the deal in progress due to financing.

Unlike earnest money, down payment money cannot come back to the buyer. Down payments are necessary for the closing of the real estate transaction so there is no other means in which to close the deal.