Is Earnest Money Included in Down Payment?

Purchasing a home involves several financial components. Two key financial terms are “earnest money” and the “down payment.” Earnest money demonstrates a buyer’s commitment to a purchase agreement, while the down payment is the initial upfront contribution towards the home’s price. Earnest money is typically part of the total down payment, reducing the cash required at closing.

Understanding Earnest Money

Earnest money, often called a good faith deposit, is a sum a buyer provides to a seller to show commitment to a home purchase. This deposit secures the offer, signaling the buyer’s seriousness. Its purpose is to compensate the seller for taking the property off the market while the buyer completes due diligence.

Earnest money typically ranges from 1% to 3% of the home’s purchase price, though it can be higher in competitive markets. This payment is usually made shortly after the purchase agreement is signed or an offer is accepted. The funds are held in a neutral third-party escrow account, managed by a title company, real estate brokerage, or an attorney, until the transaction closes.

Understanding the Down Payment

A down payment is the initial portion of the home’s purchase price a buyer pays upfront. Its purpose is to reduce the amount borrowed from a lender, potentially securing more favorable loan terms. It also serves as a direct financial commitment from the buyer, demonstrating their investment in the property.

Down payments vary significantly, typically ranging from 3% to 20% or more of the home’s purchase price, depending on loan type and buyer’s financial situation. Some conventional loans allow low down payments, and certain government-backed loans may not require a down payment for eligible buyers. The full down payment is due at closing.

How Earnest Money Contributes to the Down Payment

Earnest money is not an additional fee but an advance payment credited toward the buyer’s down payment or closing costs at closing. This credit is reflected on the closing statement, reducing the total funds the buyer needs to bring. It functions as a prepayment of a portion of the down payment.

For example, if a home requires a $20,000 down payment and the buyer paid $5,000 in earnest money, the buyer would only need to provide an additional $15,000 at closing. If the earnest money deposit exceeds the required down payment, any excess funds are applied towards other closing costs.

What Happens to Earnest Money

The disposition of earnest money depends on the home purchase transaction’s outcome. If the sale proceeds to closing, the earnest money held in escrow is applied as a credit towards the buyer’s down payment or other closing costs. This means the buyer does not pay the earnest money twice; it becomes part of their total financial contribution.

However, if the deal does not close, the earnest money’s fate depends on the reasons for termination, governed by contingencies in the purchase agreement. If the buyer backs out due to a valid contingency (e.g., failed home inspection, appraisal below contract price, inability to secure financing), the earnest money is returned. Conversely, if the buyer withdraws without a contractual reason or misses deadlines, they may forfeit the earnest money to the seller. In cases of dispute, the escrow holder may retain the funds until a resolution is reached through negotiation, mediation, or legal action.