Real estate transactions involve a significant amount of money, and it is essential to understand the different terms and concepts involved. Two of the most common terms used in real estate transactions are earnest money deposit (EMD) and down payment. While both payments are made at different stages of a real estate transaction, they serve different purposes.

What is an Earnest Money Deposit?

An earnest money deposit is a payment made by a Buyer to Seller as a sign of good faith. It is typically a small percentage of the total purchase price, usually ranging from 1/2% to 2% of the contract price in resale purchases.  Builders tend to require a larger earnest money deposit for new construction.  These can range from 2%-10%. The purpose of the earnest money deposit is to show the Seller that the Buyer is serious about purchasing the property.

Once the Seller accepts the offer, the earnest money deposit is held in an escrow account until the closing of the sale. At closing, the deposit is credited towards the total purchase price of the property. If the buyer fails to perform as obligated per the contract, the Seller may keep the earnest money deposit as compensation for taking the property off the market.  Failure to perform does NOT encompass valid contingencies including, but not limited to a home inspection, appraisal, financing approval, home owner association document review and more.  Failure to perform can include actions such as a loan fraud, a Buyer's failure to cooperate in good faith with their lender, and other actions along those lines.   

What is a Down Payment?

A down payment is a payment made by a buyer towards the total purchase price of a property. It is typically a percentage of the total purchase price, usually ranging from 3% to 20% (as little as 0% when using a VA loan and other select programs). The purpose of the down payment is to reduce the amount of money that the buyer needs to borrow from a lender. Most lenders require a down payment to secure the mortgage loan. The more significant the down payment, the lower the loan amount, and the lower the monthly mortgage payments.

For example, a 20% down payment on a $300,000 home purchase would require a payment of $60,000. This reduces the mortgage loan amount to $240,000, resulting in lower monthly payments.

Key Differences between an Earnest Money Deposit and a Down Payment

The key differences between an earnest money deposit and a down payment are as follows:

1. Purpose: The earnest money deposit shows the Seller that the Buyer is serious about purchasing the property, while the down payment is a payment made towards the total purchase price to reduce the loan amount.

2. Amount: The earnest money deposit is typically a small percentage of the total purchase price, while the down payment is a more substantial percentage of the total purchase price.

3. Timing: The earnest money deposit is made when the Buyer submits an offer, while the down payment is made at closing.

4. Refundability: The earnest money deposit is typically non-refundable if the Buyer fails to perform as obligated per the contract of sale.  If the Buyer terminates a contract due to a valid contingency within the appropriate time frame of that contingency, then EMD should be returned to the Buyer in full unless specifically stated otherwise in the Contract.  In contrast, the down payment is not made until settlement.  In the event the settlement does not occur, then no down payment will be made, so there will be nothing to return.  

In summary, while both an earnest money deposit and a down payment involve making a payment towards the purchase of a property, they serve different purposes and are made at different stages of the transaction. As a Buyer, it is essential to understand the differences between the two to ensure that you are making the right payment at the right time and for the right reason.