Does Earnest Money Go Toward Your Down Payment? Find Out Here

If you’re in the process of buying a home, you’ve probably heard about earnest money and down payments. These are two key financial commitments buyers make during the homebuying process, but they serve different purposes. So, does earnest money go toward your down payment? In most cases, yes, but let’s break it down in this Redfin article so you know exactly how it works.

Key takeaways:

• Earnest money is a good-faith deposit that shows the seller you’re committed.
• Earnest money is not the same as a down payment, but it’s usually applied toward your down payment at closing.

What is earnest money?

Earnest money is a deposit you make after your offer is accepted to demonstrate to the seller that you’re serious about purchasing their home. Think of it as a good faith deposit – it reassures the seller that you’re committed to following through with the transaction. 

While not legally required, earnest money has become a standard practice in real estate transactions. Whether you’re buying a home in Denver or a home in Atlanta, you’ll likely need to put down earnest money as a sign of your commitment before making a down payment.

How earnest money works

1. Earnest money is typically 1-3% of the home’s purchase price: You submit it after the seller accepts your offer. Usually, it’s paid within 3 days of signing the purchase agreement.
2. It’s held in an escrow account: A neutral third party (escrow company or title company) holds the funds until closing.
3. It’s credited back to the buyer at closing: If the deal moves forward, your earnest money is applied toward your down payment or closing costs.

However, if you back out of the deal for reasons not covered by contingencies (such as inspection or financing), you may forfeit the earnest money to the seller.

Does earnest money go towards the down payment?

Yes, earnest money is typically applied to your down payment at closing. However, since earnest money is usually only 1-3% of the purchase price, it likely won’t cover your entire down payment, so you’ll need to bring the remaining amount when you close.

At closing, the escrow or title company transfers the earnest money to the appropriate party. If you’re financing the purchase, the money is typically sent to your lender, who applies it toward your down payment.

Here’s an example: Let’s say you’re buying a $300,000 home and putting 10% down ($30,000). If you already deposited $6,000 in earnest money, you’ll only need to bring an additional $24,000 to closing for the remaining balance of the down payment. Keep in mind that this does not account for additional closing costs you’ll need to pay for.

Can earnest money go towards closing costs?

Yes, in some cases, earnest money can be applied to closing costs instead of the down payment. This usually happens in one of the following scenarios:

Your earnest money exceeds your down payment

If your required down payment is less than the earnest money you deposited, the extra funds will go toward closing costs.

• Example: Your down payment is $8,000, but you put $10,000 in earnest money. The remaining $2,000 will help cover expenses like loan origination fees, title insurance, and escrow costs.

You’re using a no-down-payment loan

If you’re financing with a VA loan or USDA loan, which don’t require a down payment, your entire earnest money deposit can go toward closing costs instead.

• Example: You’re buying a home with a VA loan, and your earnest money deposit was $5,000. Since there’s no down payment required, the full $5,000 will help cover closing costs, reducing what you owe at closing.

What happens to earnest money if the deal falls through?

You’re likely wondering what happens – and who keeps – earnest money if the transaction falls apart. The answer depends on why the deal fell through and who backed out.

Buyer cancels without a valid reason

If the buyer simply changes their mind or doesn’t meet their contractual obligations without a valid reason, the seller typically keeps the earnest money. This serves as compensation for the time and effort the seller spent on the transaction and the inconvenience of removing the property from the market.

Buyer cancels for a valid reason (contingencies)

If the buyer cancels due to a valid reason, such as a failed home inspection, inability to secure financing, or a low appraisal, the buyer is usually entitled to a full refund of their earnest money. These reasons are typically spelled out as contingencies in the contract, giving the buyer a way out without losing their deposit.

Seller cancels or breaches the contract

If the seller backs out or breaches the terms of the agreement, the buyer is generally entitled to a full refund of the earnest money. In some cases, the buyer might also be able to pursue further damages, depending on the situation.

Disagreements over earnest money

If there’s a dispute between the buyer and seller over who gets the earnest money, it may remain in escrow until the issue is resolved. If both parties can’t agree, the funds may need to be handled through legal channels.

How to protect your earnest money

To avoid losing your earnest money if the deal falls apart, consider the following: 

1. Include clear contingencies in the contract: Make sure your contract includes contingencies that protect you if something goes wrong. Common contingencies include home inspection, financing, and appraisal contingencies.

2. Pay attention to deadlines: Real estate contracts come with strict deadlines. If you miss key deadlines (like for inspections or loan approval), you risk losing your earnest money. Be diligent about meeting all the required timelines.

3. Keep documentation of all communications: Always keep records of your communications with the seller or the seller’s agent. If a dispute over earnest money arises, having a clear paper trail can help protect your interests.

4. Use an escrow account: Ensure your earnest money is held in an escrow account, managed by a neutral third party. This protects both you and the seller, and ensures that the funds aren’t released until all conditions are met. If there’s a dispute, the money stays in escrow until it’s resolved.

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