Buying or selling a home, especially for the first time, can introduce a slew of phrases each with their own definition and application toward real estate practice. Escrow, deposit, and down payment are three terms you’ll most likely hear the most. We’ll be defining each of them, when they are relevant, who pays them, and why.
The two terms that are almost identical are the deposit and the down payment. A deposit, also known as ‘earnest money’, is the first payment you make when you sign a purchase agreement and is typically paid within the first 5 days after the contract is executed. It is referred to as earnest money because it implies the buyer is acting in good faith and serious about purchasing a home, proving their commitment with cash up front. In the state of Pennsylvania, this deposit is typically held by the seller’s broker in an escrow account and can sometimes be held by the title company or the buyer’s broker if necessary. Most deposits are a minimum of 5% of the purchase price, with more money strengthening the offer. It can be nerve racking thinking you’re pouring thousands of dollars into a deal that may not work out, but there are plenty of contingencies that act as a safety net so you don’t lose your deposit. If the buyer walks away without using one of the contingencies set in the purchase agreement, then the buyer forfeits their deposit to the seller. When the contract is released based on a contingency, the buyer gets all of their deposit back. If you make it to settlement, the deposit is shown as a credit toward the closing costs; you can view the earnest money deposit as a part of your down payment. We tell our clients to look at it like a savings account, where money is put in a holding place to use at the end of the deal.
While the earnest money deposit has to do more with the purchase agreement, your down payment has more to do with your loan. The down payment is the money a buyer pays toward the purchase of their home. The rest of the purchase is financed through a loan. The down payment typically falls between 3%-20%. Similar to the deposit, the more money you put down, the better your outcome is. A lending facility is more comfortable approving a loan for someone who pays more up front. The lender has less to lose, and with a higher down payment, you can get better terms for your loan that reduce the monthly payment or get rid of your PMI (property mortgage insurance). A higher down payment can also strengthen your offer. If two offers on a home are identical, but one has a 3% down payment and the other has a 20% down payment, the offer with a 20% down payment will win.
While down payment and deposit are similar in that they define methods of payment, escrow is something else. Escrow is a term used for an arrangement where a third party temporarily holds funds for an agreed upon reason. We already discussed the earnest money deposit, which is held in an escrow account by the seller’s broker (the third party). Other types of escrows can be taken and held. If the seller needs to provide something to the buyer like a repair or documentation; the buyer and seller can agree that the seller deposits money into a third party escrow account until the issue is resolved. Upon resolution, the money held goes back to the seller. In this case, you will need to agree to terms including but not limited to an escrow amount, stating the purpose of the escrow, a time limit for the outstanding item(s) to be completed, and documentation of the agreement will need to be signed by both parties.
Escrow, deposit, and down payment are simple to understand, and as just as easily confused with each other. Consider taking a first time home buyer course or making flash cards to familiarize yourself with terms you’ll encounter as you buy or sell your home.
Stephanie Slapin
February 2, 2022