When buying a home, you’re sure to hear a number of new terms from your lender and your realtor. Two important ones to make note of are the down payment and earnest money deposit. Both involve cash that you’ve saved up to put toward the purchase of your home.

You can think of a down payment as an assurance to your lender that you’re committed to your home and less likely to default on your mortgage. And, you can think of earnest money as an assurance to the seller that you’re serious about purchasing their home.

Below, we’ll take a more detailed look at the important distinctions between the two terms and some helpful information that you should know as you prepare to buy a home.

Earnest Money Deposit vs Down Payment

What is an Earnest Money Deposit?

An earnest money deposit shows a seller that you—the buyer—are serious about purchasing their home. It’s a type of security deposit that’s made to the seller after the buyer and seller agree to a purchase contract in writing and before settlement. And, unlike a down payment or closing costs, an earnest deposit isn’t an extra thing that you need to save up for. Instead, it’s part of the money that you already saved for the down payment or closing costs; you just put it on the line earlier in the home buying process to assure the seller that you really do intend to buy their home.

Earnest money deposits aren’t always required, but they can help your offer stand out, especially in a competitive housing market. A seller may choose an offer with an earnest deposit over others because it’s potentially less risky. The buyer has something on the line if they back out of the sale without a valid reason.

How Much is an Earnest Money Deposit?

Earnest money deposit amounts vary, but most are between one percent and five percent of the home’s sale price. If you’re purchasing a home for $550,000, expect to make an earnest deposit of $5,500 to $27,500. For new construction homes, an earnest deposit could be as high as ten percent.  The exact amount is simply a negotiation between the buyer and the seller, whereby the offer is stronger when the earnest money deposit is higher.

Exactly how much a buyer should offer depends on a few factors. For example, sellers might want more earnest money from cash-buyers versus buyers who use a mortgage for financing. How competitive the market is also affects the amount. If you’re the only buyer putting an offer in, an earnest deposit of one percent may be enough. If there’s a lot of competition, be prepared to offer up to five percent or even more. In some cases, a flat deposit—rather than a percentage of the purchase price—could work.

Since earnest deposits are a guarantee to the seller, the seller can accept, negotiate, or outright reject a buyer’s proposed earnest deposit amount. That’s why it’s so important to talk to your realtor during this part of the home buying process. Together, you can come up with a figure that a seller will accept without putting your finances at risk.

What Happens to Your Earnest Money Deposit?

Typically, buyers write a personal check for the earnest money deposit or wire the funds directly. Then the buyer’s broker or a title company holds onto the funds in an escrow account. The money isn’t given to the seller. In many cases, it’s cashed and held in an escrow account. In others, it’s never actually cashed.

If you buy the house…

As long as you follow through and purchase the property, your earnest deposit will go toward the closing costs or down payment for your home. You won’t lose out on any of it because you’ve kept up your end of the deal. If you don’t need to put money down or pay closing costs for your loan type, the earnest money would be returned directly to you. This may happen with VA loans.

If you don’t buy the house…

Typically a buyer will have a certain number of days to perform their due diligence, or inspection of the home.  If you walk away from the home and terminate the contract during this period, your earnest money is typically returned to you.  The important thing is to read your contract and understand when and why you can back away and not lose your earnest money deposit.  If you are terminating or not performing on the contract for a reason not permitted by the agreement, you may stand to lose your earnest money deposit.

What is a Down Payment?

A down payment is money that you’re putting toward the purchase of your home. It’s expressed as a percentage of the purchase price of the home. Not only does your down payment affect how much money you need to borrow, but it may also affect your interest rate. If you make a large down payment, the mortgage is less risky for the lender. And, they might be more likely to offer you a lower interest rate.

How Much of a Down Payment is Required?

Down payment requirements vary, depending on the type of mortgage that you’re getting and the lender. You’ve probably heard that you need a 20 percent down payment to purchase a home. While putting 20 percent down will lower the amount you need to borrow and expand your funding options, it isn’t always necessary. In 2021, the average down payment for first-time homebuyers was 7 percent and the average for repeat buyers was 17 percent.

Common down payments by loan type are:

• First-time homebuyer conventional mortgage: As low as 3% down
• Repeat homebuyer conventional mortgage: 10% to 20%
• VA Loans: 0% down
• USDA Loans: 0% down
• FHA Loans: As low as 3.5% down