When you start the home buying process for the first time, you will come across many new terms and phrases. With agents and lenders using terms common to their industry, it can sometimes feel like they are speaking a foreign language. Since this is the time that you are making probably the biggest financial commitment of your life, you need to make sure you understand exactly what is happening. Having an understanding of the home buying process along with the terms that real estate agents utilize will help you to be prepared.
You may have heard the terms earnest money and down payment. You may even think they are the same things. These are important terms to understand the difference in since they involve large sums of your money being paid. Let’s take a look at what these terms mean and how they will affect the purchase of your home.
What is a Down Payment?
A down payment is a type of payment, often in cash, made in the early stages of a purchase of an expensive good or service. The payment represents a percentage of the full purchase price. In some cases, the down payment is not refundable if the deal falls through because of the purchaser. In most cases, the purchaser makes financing arrangements to cover the remaining amount owed to the seller.
The down payment is deducted from the purchase price of your home. Your mortgage loan will cover the rest of the price of the home. The higher the down payment, the lower the interest payments will be on the remainder of the loan.
What is Earnest Money?
Earnest money is a dollar amount buyers put into an escrow account after a seller accepts their offer. Buyers do this to show the seller that they are entering a real estate transaction in good faith. It gives the seller peace of mind to go forward into the next steps of the transaction. It proves you are sincere—or earnest—about this purchase. While you wait to close on your house, the money is deposited into an escrow account with the seller’s broker, title company or escrow company.
Earnest money is important because once you enter into a real estate contract with the seller, the home will then be taken off the market as you go through the process of having a home inspection and closing on your mortgage. Earnest money protects the seller against you changing your mind midway through the process and backing out of your purchase contract, leaving that seller to have to start fresh and list that home all over again.
Typical Payment Amounts
- Earnest Money
The amount you will deposit as earnest money will depend on factors such as policies and limitations in your state, the current market, what your real estate agent recommends, and what the seller requires. On average, however, you can expect to hand over 1–5% of the total home purchase price.
In some real estate markets, you may end up putting down more or less than the average amount. In a market where homes are not selling quickly, the listing agent may note that the seller requires only 1% or less for the earnest money deposit. In markets where demand is high, the seller may ask for a higher deposit, perhaps as much as 2% to 3%. Your real estate agent may recommend that you are more likely to win a bid if you give the seller a large deposit. In fact, the seller may be willing to negotiate on the purchase price a little if you make a bigger good-faith deposit.
- Down Payment
The amount of down payment is decided by the mortgage lender. Traditionally, this was set at 20 percent of the purchase price, but less is normally acceptable to lenders nowadays. Real estate agents may still recommend the 20 percent figure and for good reason though. Offering the 20 percent figure as a down payment will make the seller more likely to accept the offer. The further away from this amount you are, the more it could negatively affect your chances of having your offer accepted.
When trying to decide how much you should put down on a home, play around with a mortgage calculator to determine an amount that works best for your finances. As you explore, remember that in addition to your down payment, you will have some other up-front costs you will need to pay at closing, collectively called your escrow funds. It can include your closing costs, prorated taxes, title fees and more.
Here’s a breakdown of down payment percentages from buyers who purchased homes with a mortgage in 2019:
- 20% of buyers have a down payment of more than 20%
- 19% of buyers have a down payment of 20%
- 21% of buyers have a down payment of 10-19%
- 9% of buyers have a down payment of 6-9%
- 17% of buyers have a down payment of 3-5%
- 10% of buyers have a down payment of less than 3%
- 5% of buyers don’t remember the size of their down payment
Getting Pre-Approved and Your Credit Score
Before you start the home buying process, make sure that you have been pre-approved for a mortgage. Once you have found your dream home, it will make the buying process so much easier.
Then again, buying a home starts before you start looking for a property. You also need to make sure that you have an excellent credit score. Do not hesitate to check if you are not sure. If you are planning to buy a home within the next couple of years, planning ahead is essential, and that means being financially prepared.
There are more costs associated with buying a home than earnest money and the down payment. Familiarize yourself with closing costs and lending costs to make sure you do not come across any surprises. Ask your mortgage brokers smart questions so you are not surprised by anything in the home financing process.
Final Thoughts
Understanding the difference between earnest money and a down payment is a key component of buying a house. Make sure you understand contract timelines, financing, and everything else it takes to have a successful home purchase.
When choosing an escrow company there can be many important factors to evaluate. Fees, location, staff and even recommendations from friends and colleagues are all things to consider. With Citrus Heritage Escrow by your side, you can rest assured that when you receive your settlement check, you’ve gained the maximum benefit from your home sale or purchase.
Call us today with any questions or concerns. Our professional Escrow Agents will help you through this exciting yet confusing process. (951) 335-7200