Investors seeking to purchase a commercial property frequently decide between making an earnest money deposit or a down payment. They both entail resources that represent genuine purchasing interests to sellers. However, there are major differences in functions you should be aware of. Let’s take a look at earnest money deposit vs down payment.
Earnest Money Deposit vs Down Payment
When making an offer to a seller, it’s critical to demonstrate your commitment and sincere desire immediately, whether through a substantial down payment or a good-faith cash deposit. Let’s examine the main distinctions between the two payments and choose which is best for you.
Overview of Earnest Money Deposit
It is a deposit made by the buyer to show that they are serious about buying a property. This deposit is typically made when the buyer makes an offer, and it’s held in an escrow account until the sale is finalized.
This good faith money shows the seller your commitment to completing the deal. With this payment in place, the seller may take the property off the market, away from other competitive buyers. During this exchange, a contract is drawn up stating the conditions for a refund.
If the sale goes as planned, the deposit will be applied toward the down payment or closing costs. However, if it falls through, it may be returned to the buyer or used to cover expenses incurred by the seller.
Overview of Down Payment
A down payment in real estate is a payment made towards purchasing a property, usually at the time of closing. It’s a non-refundable upfront payment with the balance paid by obtaining a mortgage loan.
The purpose of a down payment is to reduce the overall cost of the property and to provide you with collateral for the loan. Typically, the size of a down payment can significantly impact the overall cost of a property.
A larger down payment can reduce the amount of the mortgage loan, resulting in lower monthly payments and a lower overall interest cost. However, a larger down payment may also require you to have a more significant amount of savings or assets upfront, which can be challenging.
Comparing an Earnest Money Payment to a Down Payment
Now that you’re familiar with these concepts, it is also important to understand their common similarities and differences before heading into the market.
Similarities
- Both are payments made toward the purchase of a property
- Both payments demonstrate the buyer’s commitment to the purchase of a said property
- Both payments may be applied toward closing costs or other expenses related to the purchase of a property
- Both payments may be held in an escrow account until the sale is finalized and a PSA has been signed.
Differences
There are significant differences between both payments, each of which is vital in the purchase of a property. Let’s examine some of these variations:
Timing
An earnest money payment is made at the beginning of the property-buying process, while a down payment is made at the end.
Percentage
Earnest money payments are generally smaller than down payments, commonly ranging from 1% to 2% of the purchase price. On the other hand, down payments are a more significant percentage of the purchase price, frequently ranging from 15% to 35% for traditional and SBA loans, both 7(a) and 504, 10% to 15%.
Despite the fixed percentages, down payments differ based on how much cash you are prepared to pay upfront. You can pay within the required range or pay as much as the sale price as you can.
However, the most viable option may differ from scenario to scenario, so if you are dealing in the midwest/ Cincinnati, Northern Kentucky area, real estate experts like Si Vales Valeo Real Estate can help with the complexities of a real estate transaction process.
Purpose
An earnest deposit is a way for a buyer to show their commitment to the purchase. With this payment in place, a seller may take the property off the market.
A down payment, on the other hand, is simply the required part of the purchase price.
Refundability
Sometimes, the deposit may be refundable if the sale falls through. However, this is typically only if the buyer is not at fault for sale falling through. Down payments are generally not refundable.
When to Use Earnest Money
You should make use of this payment option when:
- Making an offer on the property
- When entering into a contract
- When securing financing
Once the seller accepts your offer, you typically enter a contract that outlines the terms of the sale, including the purchase price and any contingencies that need to be met. In the state of Kentucky, for example, some real estate contingencies include:
- Property cost appraisal contingencies
- A financing contingency
- Sale of current property contingency, amongst others
When acquiring a property, it is essential to understand contract contingencies, and is crucial that you discuss the contract with your consulting experts.
When to Use Down Payment
As a buyer, you would have to make a down payment for a property if you would obtain a mortgage to finance the purchase. So, there is no specific deal that would not require making a down payment. If you make a purchase, you would have to make a down payment.
Which Payment is More Important?
It goes without saying that a down payment is the more important of the two costs to be incurred. The down payment is practically what seals the deal, while the earnest deposit only allows you to get an edge over other potential competing buyers, which can be very necessary for commercial real estate.
The down payment also significantly impacts the overall cost of the property, making it even more critical.
Final Verdict
Both payments are essential concepts in the property purchase process. They play different roles, and both may often have to be used in a single transaction.
In the absence of the deposit, you may lose out on a property purchase, making it quite important. However, the downpayment remains the most important payment.
