does earnest money go towards down payment

Does Earnest Money Go Towards Your Down Payment On A Home

You made an offer, and—great news—it was accepted.

Now, you just need to go to the title office and pay your $5,000 in earnest money.

But wait. What happens to your earnest money after making that deposit?

As with most things, there’s an easy answer and a more difficult one.

Generally, your earnest money will go toward your down payment on a home. But there are some nuances involved that you might need to know.

The Basics: Paying Earnest Money

First, what is earnest money? When you make an offer on a home, you’ll typically put down a deposit of earnest money, or a diligence fee. This is a good-faith gesture that shows the seller that you’re serious about wanting to buy the home. Your earnest money will be held in escrow until the sale is closed.

does earnest money go towards down payment

When Do You Pay Earnest Money?

You’ll usually pay your earnest money deposit when you submit your offer. Your agent put the check into escrow; a third-party account that holds on to the funds until it’s time to disburse them.

How Do You Pay Earnest Money?

Your earnest money should be in the form of a cashier’s check or wire transfer. You don’t want to hand over a personal check because checks take a long time to clear. And escrow companies frequently reject them because they can’t verify that they’re real. Don’t ever pay earnest money directly to the seller. Always pay it into escrow.

Is Earnest Money Negotiable?

Yes and no. Technically, you can negotiate earnest money. But it’s one of the least negotiable elements of a real estate transaction. The amount is generally 1 to 2 percent of the home’s purchase price. So, on a $200,000 purchase agreement, you might pay $2,000 or $4,000 in good faith deposit.

Earnest money has nothing to do with your credit score. If the buyer doesn’t want to complete the deal, the diligence money bolsters the seller’s financial position.

This brings us to…

does earnest money go towards down payment

How Much Earnest Money Should a Buyer Pay?

The amount of earnest money a buyer may pay can vary greatly. It all depends on the market you’re in, the price of the home, and how much competition there is for that particular property.

In a hot market, you might need to offer more earnest money to show the seller that you’re serious about buying the house. In a slower market, you might get away with paying nothing at all—but this is rare.

Your real estate agent can give you better insights into the amount of deposit money that will be found acceptable.

Should You Make a Larger Earnest Money Deposit?

In some cases, you might want to consider making a larger earnest money deposit. This can be a good idea if you’re competing against other buyers or if the seller is particularly motivated to sell the property.

A larger earnest money amount can also help you win a bidding war. If you’re in a situation where there are multiple offers on a home, a larger earnest money deposit can make your offer more attractive to the seller.

Of course, you’ll want to be sure that you’re comfortable with the amount of money you’re putting down. You don’t want to put yourself in a situation where you can’t afford to buy a home if the deal falls through and you lose your earnest money.

How Big Can an Earnest Money Deposit Be?

The sky’s the limit. In theory, you could put down $100,000 in earnest money on a home. But most people don’t have that kind of cash lying around unless they just sold their previous house. Realistically, your earnest money deposit should never exceed the amount of your down payment plus your projected closing costs.

does earnest money go towards down payment

What Happens to Your Earnest Money?

Once your deal closes, your earnest money is applied to the down payment and/or your closing costs. Importantly, it may be applied to both or either; it’s entered into a pool of money in escrow that’s used to pay off the entirety of your balance.

To be clear, your earnest money deposit is not extra cash that the seller gets to pocket. It’s there to protect the buyer and the seller if the deal falls through.

If you’re just wondering whether you “lose” your earnest money, the answer is no. It does get applied to your transaction, eventually. But you can lose your earnest money, which is the more important part.

When Could You Lose Your Earnest Money?

If you back out of the deal for any reason not expressly allowed in your contract, you could lose your earnest money. The conditions will be outlined within the purchase contract by your real estate agent.

If you’re buying a home and you get cold feet, you might be out of luck. The same goes if you can’t get financing or if you’re simply changing your mind.

If the seller backs out of the deal, you should get your earnest money back. The same goes if the home doesn’t appraise for the sale price (if you didn’t waive the appraisal contingency) or if the home doesn’t pass home inspection (if you didn’t waive the inspection contingency).

Your contract will likely specify a timeline for getting your earnest money back.

Now, note that I mentioned a lot of contingencies there. Today, a lot of buyers are waiving contingencies constantly. When you waive your contingency, you are essentially forfeiting your right to get your earnest money back for those issues. It’s a gamble, even if it is a measured one.

When Shouldn’t You Offer Earnest Money?

If you are waiving contingencies, putting down an earnest deposit is a gamble. Always remember the most important rule: Don’t gamble any amount that you can’t afford to lose.

Let’s say you put down $20,000 in earnest money on a $400,000 house and waive your appraisal contingency. The appraisal falls short by $50,000. Your bank won’t lend you anything more than 80% of $350,000. You need to come up with the difference between the appraisal and the sale price… or walk away and potentially lose that $20,000 in earnest money.

And if that sounds like a lot of earnest money, it is. But many buyers have grown so frustrated with the market that they’re throwing down large volumes of money from the start.

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Do You Ever Get Your Earnest Money Back at Closing?

So, does earnest money go towards a down payment? It can, but it’s also possible that you will get money back at closing. If you overpay on the transaction, money will be returned to you from escrow.

This happens all the time with home buyers. They’ll put down, say, $6,000 in earnest money and then get a check for $500 at closing because their closing costs were a little overestimated.

But you’re not going to get a significant amount of money back unless something was calculated incorrectly. The earnest money is intended to be used toward your down payment and/or closing costs, even if it is a deposit.

FAQs

Why should you pay earnest money?

When you make an offer on a home, the earnest money deposit shows the seller that you’re ready and willing to buy. The more you put down the more serious the seller will believe you to be.

How is earnest money different from a down payment?

Your down payment is paid at closing and is used to cover a portion of the purchase price that the mortgage doesn’t cover. Earnest money is paid upfront and is generally used to cover a portion of your closing costs or a portion of the down payment.

Can you get your earnest money back?

It depends on the contingencies in your contract. If you back out of the sale for any reason that’s not protected, you could lose your earnest money deposit. Changing your mind isn’t a valid excuse. Not being able to secure financing due to a change in financial situation is.

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Conclusion

When you make an offer on a house and pay earnest money, an escrow account will be opened between you, the buyer, and the seller.

There are no real regulations on earnest money deposits. The amount is really up to you and the seller, although it’s common for buyers to make deposits that hover around 1% of the sale price. If you want to offer more, you can offer more to secure the ideal. If you want to offer less, you run the risk of having your offer rejected.

At closing, you will need to pay for your down payment and any closing costs that are your responsibility (not being paid by the bank or the seller). Your earnest money will still be in the account—you will need to pay the difference.

Importantly, your earnest money is always “yours” (unless you back out of the deal). It always gets applied to your side of the transaction. Whether it’s applied to the down payment can be more or less a matter of opinion; what’s important is that all the money you owe at closing is paid.

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