When purchasing a home, it is no surprise to learn that funds are required to close the deal. What many buyers don’t know is how much cash they will need and where it must be paid. Understanding the “money piece” of the homebuying process can be daunting, but once you learn what is expected or needed to purchase a home or property, you can financially prepare. One of the first steps is finding and working with a knowledgeable and experienced group of professionals to answer questions and take you through the process. An experienced realtor, mortgage broker and escrow officer are all valuable experts who can explain the monies required at each stage of the process. In this blog, we will discuss the common question and clarify the difference between a down payment and earnest money.
What are the required payments at purchase and how are they determined?
The money a homebuyer must pay during the offer to purchase is broken down as follows:
Earnest money, which is often mistaken as the down payment by a first-time or inexperienced home buyer, is funding that the homebuyer provides in good faith to show the seriousness of their offer. This deposit lets the seller know that the offer is genuine, solidifying the buyer’s intent. Typically, a buyer is expected to write a check or wire anywhere from 1 to 3 percent of the price of the home when they make an offer. If the offer is accepted, the earnest money effectively goes towards the final payment of the sale price.
The other major cash outlay a buyer must plan for is a down payment. The down payment is a larger sum paid by the buyer at the time of closing on a property. However, before making an offer the buyer should have a fair idea of what they can afford and how much money they are comfortable making for the down payment. A down payment usually ranges from 3 to 20 percent of the agreed-upon purchase price. It’s important to be realistic, assessing one’s savings, current financial situation and long-term goals.
What happens when the money goes into the escrow account?
The purpose of the escrow account is to protect the buyer and seller by holding the earnest money until the sale is finalized under the conditions detailed in the contract. The money is typically held by a title company (a neutral third-party agent). When the deal closes, as previously mentioned, the deposit is applied to the buyer’s down payment. However, in the event the negotiation falls through and the buyer backs out for reasons not deemed valid by the contract, the seller may get to keep the earnest money.
What percentage is best for a downpayment and how is it determined?
While lenders typically prefer a 5 percent minimum, buyers who have a 20 percent down payment are more favorable to the seller. The bigger down payment signals stronger financial capability with banks and mortgage brokers. Having a bigger down payment can give the buyer an edge over other potential buyers, particularly when the property is in a hot market for sellers.
With a 20 percent down payment, the buyer is likely to avoid having to pay private mortgage insurance (PMI). This is a separate insurance policy that protects the lender if the borrower/buyer defaults on the mortgage. It’s typically paid monthly on top of the mortgage and its cost varies from $35 to sometimes more than $100 per month. The borrower can stop paying PMI when their mortgage balance is less than 80 percent of the appraised value of the property. Also, PMI should not be confused with homeowners’ insurance.
Determining the best percentage depends on multiple factors, such as loan type, property type, the home price and personal finances (including credit score). While 20 percent has been the standard for many years, most buyers don’t have access to that much liquid cash. In 2023, the average down payment was actually 15 percent. It’s important to consult with a HUD-certified housing professional to determine individual-specific down payments. If a higher down payment is possible, it often results in a lower interest rate on the loan and fewer loan costs.
At Landmark Title, our residential escrow teams in Arizona and Nevada work directly with professional realtors and their clients to help make the dream of home ownership come to life. If you are interested in partnering with an escrow and title agency that prioritizes safe and secure transactions get in contact here to learn more about our services and team.