Earnest money goes toward your down payment, your closing costs, or both. The deposit sitting in escrow since the seller accepted your offer is credited to you at the closing table, reducing the cash you need to wire or bring that day. How it splits between down payment and closing costs depends on your loan type, your down payment amount, and the size of the deposit itself.
Credit Toward the Down Payment
For most buyers, the deposit is applied straight to the down payment. Buy a $400,000 home with 10 percent down, put $5,000 in earnest money up front, and you owe $35,000 more at closing instead of the full $40,000. The closing agent subtracts the escrowed funds from what you still owe.
Earnest money deposits typically run 1 to 3 percent of the purchase price, though competitive markets push that higher. Whatever the amount, every dollar in escrow reduces your cash to close and becomes part of your equity in the home the moment the deed records.
Credit Toward Closing Costs
When there’s no traditional down payment to apply the deposit to, it covers closing costs instead. This is common with VA loans, which let eligible borrowers finance 100 percent of the purchase price. In that case the full earnest money deposit shifts to settlement charges like the appraisal fee, title insurance premium, recording fees, and lender origination costs.
The same thing happens when your deposit is larger than your down payment. Put down $12,000 in earnest money on a loan that only requires $10,000 down, and the extra $2,000 is applied to closing costs. If the deposit somehow exceeds both the down payment and the closing costs combined, the surplus comes back to you as a refund after closing. The settlement agent handles this accounting when preparing the final numbers.
How the Credit Appears on Your Closing Disclosure
Federal regulation requires your earnest money to appear on the Closing Disclosure, the official line-by-line accounting of the transaction. The deposit shows up in two places: as “Deposit” in the Calculating Cash to Close table that compares your original Loan Estimate to the final numbers, and again in the Summaries of Transactions section under amounts already paid by or on behalf of the borrower, also labeled “Deposit.”1eCFR. 12 CFR 1026.38 – Content of Disclosures for Certain Mortgage Transactions (Closing Disclosure) In both places it reads as a credit that reduces your cash to close.
If part of your deposit was used to pay a closing cost before the closing date, that portion won’t appear on the Deposit line. It shows up on the specific closing cost line where it was applied, marked as borrower-paid before closing.2Consumer Financial Protection Bureau. Section 1026.38 Content of Disclosures for Certain Mortgage Transactions (Closing Disclosure) That split keeps every dollar accounted for once rather than twice.
What Your Lender Will Want to Verify
For the deposit to count toward your minimum required investment, the lender has to confirm where it came from. At a minimum, expect to provide a copy of the canceled check or a receipt from the escrow holder confirming the deposit.3Fannie Mae. Earnest Money Deposit
Large or recent deposits get extra scrutiny. Underwriters typically review at least 60 days of bank statements, and anything that doesn’t match your regular income needs a paper trail. Gift funds from a family member require a signed gift letter stating there’s no expectation of repayment. Money from selling a car needs a bill of sale. Funds that can’t be sourced with documentation won’t count toward your down payment, and that gap can derail a closing you were counting on.
What Happens if the Deal Doesn’t Close
The credit only happens if you actually close. When a deal falls apart, whether the deposit comes back to you turns on the contingencies in your purchase contract.
- Inspection contingency: if the inspection reveals significant problems and you and the seller can’t agree on repairs or a price reduction, you can walk with your deposit.
- Financing contingency: if you can’t secure mortgage approval despite a good-faith effort, the contract terminates and the deposit is returned.
- Appraisal contingency: if the home appraises below the purchase price and the seller won’t lower it, you can cancel and keep the money.
- Home sale contingency: if you need to sell your current home first and can’t find a buyer, this lets you exit without forfeiting the deposit.
VA-backed loans add a protection called the VA Escape Clause. If the VA appraisal comes in below the purchase price, the buyer can back out without losing earnest money, negotiate a lower price, or cover the difference in cash.4U.S. Department of Veterans Affairs. VA Escape Clause – VA Home Loans
Walk away for a reason your contract doesn’t cover, and the seller is usually entitled to keep the deposit as liquidated damages. Waiving contingencies to win a bidding war is where buyers get burned. And the IRS classifies forfeited earnest money as a nondeductible payment, so you can’t claim it as a capital loss or any other deduction on your return.5Internal Revenue Service. Tax Information for Homeowners Losing a deposit means losing it in full.