When buying a home, you’ll likely encounter the term “earnest money.” This guide explains what happens to that money at closing.
Understanding Earnest Money
Earnest money, also known as a good faith deposit, demonstrates your commitment to purchasing a home. It’s typically 1-2% of the purchase price, paid within days of an accepted offer. This money is held in escrow by a neutral third party.
What Happens to Earnest Money at Closing?
At closing, the earnest money is typically applied towards your closing costs or down payment. Let’s break down the common scenarios:
Applying Earnest Money to Closing Costs
Closing costs include fees for appraisal, loan origination, title insurance, and more. Your earnest money will first be used to cover these expenses.
Applying Earnest Money to Your Down Payment
After closing costs are covered, any remaining earnest money is usually credited towards your down payment. This reduces the amount you need to pay out-of-pocket at closing.
Getting Earnest Money Back at Closing
While less common, there are situations where you might receive your earnest money back:
- No Down Payment Loan: If you secure a loan with no down payment requirement, like a VA or USDA loan, your earnest money will solely cover closing costs. Any surplus is returned to you.
- Excess Funds After Closing Costs: If your earnest money exceeds your closing costs, and you have a traditional mortgage with a down payment, the excess may be applied to the down payment, or returned to you depending on the terms of your agreement.
- Non-Monetary Earnest Money: In rare cases, earnest money might be an asset like a car or valuable item. These are typically returned or their value applied to the purchase.
Example Scenario
Let’s say your earnest money is $5,000, and your closing costs are $4,000. In this case, the $4,000 would cover the closing costs, and the remaining $1,000 would be applied to your down payment.
Conclusion
While you don’t directly receive earnest money back at closing in most cases, it plays a crucial role in funding your home purchase. It helps cover closing costs and reduces your down payment, ultimately contributing towards the final purchase price of your new home. Understanding how earnest money works is essential for any homebuyer.
