“Earnest money” and “down payment” are two terms which get used interchangeably with new investors. But is earnest money the same as a down payment for a home loan? Let’s dive in and talk about what earnest money is, what it isn’t, and my tips for using as little earnest money as possible to secure a deal.
What Is Earnest Money?
So first, let’s define these terms outright before we start diving into how to use them to your advantage.
Earnest money is a small amount of money you’re putting up as collateral. It’s a way for the buyer to say that you’re serious about continuing the contract process and potentially closing a deal.
Earnest money does not give you exclusivity to a contract in perpetuity, there are usually some terms that come along with it. Normally this involves stipulating that you need a certain, defined amount of time to have an inspection done on the property. Sometimes you can also stipulate additional periods of time necessary for things like appraisals and insurance quotes.
The earnest money you give essentially says “If I go over this set amount of time without removing myself from the contract, you can keep that money and work with someone else. But while we have this set amount of time established, you won’t entertain other offers or walk away from the contract.”
A down payment is something else entirely. It’s an agreed upon amount you give a lender to secure financing for your investment. This is when you’re in the contract phase and are almost ready to close on the house. A down payment is usually more substantial than an earnest money deposit, about 10% – 30% of the loan.
Earnest money is normally given to the seller or the title company. I prefer to hand it over to the title company myself, but you can do whichever works best for the situation. A down payment is most often paid directly to your lender.
So while they do different things in the selling process, they’re both financial tools that can affect the bottom line of your final offer and the amount you’ll pay at closing.
Is Earnest Money the Same as a Down Payment?
No. But Also Yes.
While earnest money is given at the beginning and a down payment is paid toward the end, earnest money can often be folded into the amount of money you’ll need to put down to close on the home, but it really depends on the lender.
Often the earnest money you give will go directly towards a down payment, but you may also be able to receive a check for your original earnest deposit at closing. Talk to your lender about how they prefer to handle this and make sure you understand how the “good faith” deposit will be credited back to you before signing on the dotted line.
How Much Earnest Money Should I Give?
When thinking about your budget and figuring out how much you should set aside for earnest money, the main factor you’ll need to consider is the competitiveness of the marketplace you’re working with.
While there’s no set rule to this, the range for a “good” amount can range anywhere from $500 to $5,000. The more you’re able to put up in earnest money, the more competitive you’ll be so it’s really best to understand how hot your market is, as you could be offering more than necessary, or not enough.
Now, if you’re dealing with an off-market property or aren’t in a competitive market, you can sometimes get away with a small $50 deposit as earnest money.
Also consider who you’ll be dealing with during the sale. I’ve found that realtors and real estate agents usually want more earnest money upfront than a homeowner who’s selling it privately.
When Do I Give the Earnest Money to the Seller?
Your earnest deposit is normally given after an offer is made and accepted by the seller. You may be able to negotiate a timeframe with this, but it’s usually expected to be delivered within 3 days of being notified of the accepted offer.
This is one deadline you absolutely want to meet, as being late with your deposit can set up a negative experience for your seller that may affect how negotiations go. Be sure that you can meet the deadline and do everything you can to get in writing receipt of delivery as they may not cash it right away. You’ll still want proof that you’re a serious buyer who is making it a priority to efficiently deliver what’s needed to move this deal forward.
You can deliver it as cash, a personal or business check, or as a wire transfer if you’re out of the area though most prefer a bank or cashier’s check. If you’re mailing it, make sure you spend the money to get a tracking number and a signature confirmation. If that’s too costly, at minimum make sure you have a tracking number showing proof of delivery.
If the title company or seller provides you with an account number to ship with, be sure to record the tracking number for your records and follow up to confirm delivery once you see it’s arrived at its destination.
What If There’s No Down Payment?
Let’s say you’re able to secure financing where the lender doesn’t require a down payment. What will happen to that earnest money, can you get it back?
This is another circumstance where you’ll need to talk with your lender, as each one will have their own ways of handling this. Make sure you clearly understand the terms for this before moving forward as you don’t want to be out a $500 deposit that you were counting on being returned.
Normally (and I use that loosely), the earnest money given will be credited back to you at closing as either a deduction from the total amount owed on your loan, be deducted from your closing costs, or will be considered one of the payments on the loan. You may be able to negotiate getting a check cut to you at close if you want to, but in my experience lenders are usually not inclined to give money back once it’s already out of your pocket.
My Best Tip for Using Earnest Money Wisely
When it comes to real estate investing, the more money you have to play with, the better your chances are at growing your business so it’s in your interest to keep as much capital free as you can.
My recommendation for investors who have the opportunity to do so is to avoid the competitive marketplace as much as possible and instead go after off-market properties. These homes are going to have the lowest earnest money amounts needed because you’re not going against a competitor; it’s often just you and a seller who took you up on an offer to unload their property to you.
I hope this has helped you understand how earnest money works and why it’s somewhat (but not completely) different from a down payment. Leave a comment if you have any other tips for earnest money ideas and we’ll check them out!