As promised in past blog posts, I am writing another educational post on the topic of real estate. The feedback has been great so far, so I want to keep it going.
If you are a regular reader, you know that I typically like to discuss development, local happenings, and all things related to Philadelphia + Suburban Philadelphia. Let’s mix it up again, shall we.
Deposit. Down Payment. They sound almost the same, don’t they?
Based on my own experience, it’s probably one of the most common questions I answer as a real estate professional; and rightfully so, as they sound like one and the same. The truth is, they are not the same. “Deposit” and “Down Payment” mean different things, serve different purposes, and cater to different people, when it comes to buying and selling real estate.
Okay, let’s break this topic down PUL.com-style:
– “What is a Deposit?”
Sometimes referred to as a “deposit,” sometimes referred to as “earnest money,” and sometimes referred to as an “earnest money deposit.” It really depends on who you are talking to, and what day of the week it is (the latter being a joke).
Simply put, when the buyer gives an upfront deposit with an executed agreement of sale, it let’s the seller know that the buyer is committed to the transaction. Which means the buyer is now focused, one offer on one home; as opposed to many offers on many homes.
The deposit can be a funny thing, as every Listing Agent/Broker has a different way of handling it. Some LAs like to see a large deposit when an agreement of sale is executed (anywhere from 5%-10%, based on the purchase price), but most LAs are more lax about it after an agreement of sale is executed (anywhere from 1%-3%, based on the purchase price). Needless to say, the deposit amount can vary from one transaction to the next.
Not so simply put, here is how our local Pennsylvania Association of Realtors (aka PAR) form reads, referred to as the “Standard Agreement for the Sale of Real Estate” (aka AOS):
“Deposits regardless of the form of payment, will be paid in U.S. Dollars to Broker for Seller, who will retain deposits in an escrow account in conformity with all applicable laws and regulations until consummation or termination of this Agreement. Only real estate brokers are required to hold deposits in accordance with the rules and regulations of the State Real Estate Commission. Checks tendered as deposit monies may be held uncashed pending the execution of this Agreement.”
So as to break down the legalese, the buyer gives a deposit check to the Selling/Listing Agent, who then gives the deposit check to his/her Broker, who then deposits the deposit check into an Escrow Account, where it will then sit until either one of two things happens: 1. Everything goes as planned, both buyer and seller follow through with the agreed upon terms of the AOS (“consummation,” as noted above), and the deposit is given to the title company at closing/settlement to complete the transaction, or 2. The AOS is cancelled (“termination,” as noted above), for whatever reason as originally agreed upon (or as not originally agreed upon) by buyer and seller in the AOS, and the deposit is either returned to the buyer or forfeited to the seller (if forfeited to the seller, a portion of the deposit may even be shared with the Selling/Listing Broker, for work already put in to the “terminated” transaction).
As you can now see, for such a simple term, it can get a little complicated. My apologies for the excessive wordiness.
– “What is a Down Payment?”
Simply put, it’s the amount of money that the Bank/Lender/Mortgage Company requires the buyer contribute to the transaction in order to satisfy the terms of the agreed upon loan/mortgage. The traditional, old-school term for this would be “skin in the game.”
Now, although I mentioned that the deposit and down payment serve different purposes, they tend to get intertwined during the tail end of the buying process. As I also mentioned, if the transaction is consummated, the deposit is given to the title company at closing/settlement.
Below is an example, using basic numbers, so you can see what I mean.
Let’s say the agreed upon AOS purchase price is $100,000, and the Bank is requiring that the buyer contribute 5% into the transaction as a “down payment” (which would be equal to $5,000). Let’s also say that closing costs will run the buyer another 5% (e.g. mortgage fees, title fees, etc; also based on the purchase price, which is an additional $5,000). The buyer will then need to contribute a total of $10,000 to purchase the home, secure the loan/mortgage, and consummate the transaction ($5,000 for down payment, and $5,000 for closing costs).
Let’s also say that the LA requires a 5% “deposit” upfront, in order to execute the AOS.
Are you still with me? Good.
Here are the numbers: 5% for Down Payment ($5,000), 5% in Closing Costs ($5,000), and 5% required for Deposit ($5,000, which was given upfront); giving us a grand total of $10,000 to consummate this transaction (Down Payment + Closing Costs), again, with $5,000 already given upfront (Deposit). When the LA withdraws the buyer’s $5,000 deposit from his/her Broker’s Escrow Account, and brings it to closing/settlement, the buyer now only needs to bring $5,000 to closing/settlement. The buyer then initials, signs, and dates about six reams worth of paper documents, and walks out of closing/settlement clicking his/her heels with their new keys in hand.
Once again … whew.
It may seem simple when the subject is broached, but not everyone thinks like an accountant; and if you do not practice real estate for a living, it can be confusing. For those who are still having a bit of trouble grasping the above example, please know that you are not alone.
I hope this blog post was educational, and my goal is to post more like it in the future.