What Happens To Your Deposit When Getting A Mortgage? A Clear Strong Offer Could Make The Difference Between Being Accepted Or Declined
By Christopher Carter: Real Estate Broker Associate
February 8, 2024
Many buyers wonder where their deposits end up as they progress from a seller accepting their offer, to applying for mortgage financing, to handling all the other details involved with buying a house or condo. The answer to our question turns out to be rather simple, though is not that straightforward when you first think about it.
Some buyers may ask: Does the seller hold our deposit? Is it sent to our mortgage lender? Do we get it back at closing?
Nope, none of the above.
Residential real estate contracts used to submit offers to sellers include lines for the following entries: purchase price, initial deposit (accompanying the offer), additional deposit (and date due), mortgage loan proceeds (loan amount) and balance of purchase price (due at closing).
(The filled-in amounts only relate to the offered purchase price, not including closing costs.)
Money that buyers use to pay deposits and closing costs must be readily available cash (not financed), verified during the mortgage application process.
(Note - We use the word "cash," though green paper money and personal checks are never used in modern real estate transactions. For security, all funds must be wire transfers directly from the buyer's bank to the transaction's escrow and closing agents.)
Deposits are wired from the buyer's bank to a third-party escrow agent identified in the accepted contract who holds the money in a protected, secure bank account until closing. At this point, the money's intended use is not specified. It is being held in escrow to express the buyer's sincerity in making the offer and intent to continue forward as detailed in the contract. The application of deposit money is not defined until a preliminary Settlement Statement is prepared much later in the deal's timeline.
Deposit money still belongs to the buyer while in an escrow account, though can be subject to forfeiture if the buyer defaults on a contract provision. If a buyer decides to terminate the deal within the designated Inspection period, under the applicable contract terms, and gives proper notice to the seller, the initial deposit can be returned/refunded by the escrow agent.
The escrow agent may also be the closing agent for a transaction. Closing (settlement) agents handle the legal transfer and recording of ownership along with disbursement of all money exchanged between buyer and seller (and lender when mortgage financing is used). They also make sure that required transfer taxes, transaction charges, and service provider fees are paid. In Florida, many sellers and buyers prefer to have their own separate closing/settlement agents who cooperate to close the transaction for each side of the deal. (Personally, I prefer this arrangement of seller and buyer each having their own closing agent.)
In Florida, escrow and settlement agents can be either attorneys and law firms or licensed title companies.
Let's take a moment to discuss why there are usually 2 separate deposits made at 2 different points in the transaction timeline. The initial deposit accompanies the offer as a show of the buyer's good faith and intent to proceed. In escrow and closing agent language, buyer deposits are called Earnest Money Deposits (EMDs).
Because sellers are more comfortable with higher deposit amounts, a 2nd deposit is usually scheduled to be paid after the Inspection (Due Diligence) period has ended and the buyer decides to continue with the deal. Contract language also details how buyers can terminate the offer/contract if they don't like something in the Inspection Report, get back their initial deposits, and not have to pay 2nd deposits if they give proper notice to the seller within the required timeframe. Speak with a Florida-licensed attorney for specifics on offer/contract termination and release of deposits.
In answering today's headline question, we need to touch on a basic part of mortgage financing, the Loan-To-Value ratio (LTV). This is the relationship between a property's market value and the amount loaned to purchase it.
The buyer's down payment amount determines the initial (qualifying) LTV for any given mortgage loan. 10% down payment = 90% initial LTV.
Every loan program has its maximum LTV ratio that the lender is willing to accept when making the loan. As part of their risk management, lenders only provide a certain percentage of any property's value, the rest has to be put up by the buyer. Without enough down payment to meet a specific loan program's required LTV, the buyer will not be approved.
A fairly common buyer misconception when using mortgage financing is that the down payment is paid to the lender. No, the lender only needs dependable verification that the buyer has paid enough money toward the purchase price to meet the loan's required maximum LTV. Proof of buyer payments is provided by deposit receipts from the escrow agent and the final Settlement Statement provided to all parties just before closing.
At some point before closing and the legal transfer of ownership, the buyer has to get all money for the purchase and transaction costs to the escrow/closing agent. Buyer debit (-) and credit (+) line items are on one side of a Settlement Statement, seller debits and credits are on the other side.
Settlement Statements show all the money a buyer has paid (or will be paying) into the deal, including: deposits/earnest money, loan amount from the lender and the net amount due from buyer at closing.
The Due from Buyer line is where buyers usually end up paying the remainder of their down payments at closing. Lenders coordinate with closing agents to tell them the remaining amount due to satisfy the loan's LTV requirement after deposit amounts have been applied. Purchase price minus loan amount = down payment amount.
Buyer deposits (and the balance due at closing) pay the required mortgage down payment, along with any other buyer costs due.
Remember that higher deposits increase seller comfort and confidence, especially when considering an offer which includes mortgage financing. In order for offers to be seen more favorably by sellers (and to compete with all-cash offers), some buyers including a Financing Contingency in their offer have been known to pay total deposits equal to their full mortgage down payment amounts.
This means that if they are applying for 90% financing on a purchase (90% LTV), total deposits to the escrow agent will equal 10% of the purchase price. The point here is to pay the full down payment in the 2 deposits well before any lump sum balance due at closing. When using this strategy, be sure the seller is aware of your strong deposits, and include a written explanation in the offer. It could make the difference between your offer being accepted or declined. (Of course, only do this if you are completely sure you really want to buy that property!)
Look for a future article expanding on Financing Contingencies and successful strategies when including them in an offer.
There we are, a bit of clarification to help buyers understand how their deposits are applied, and maybe a touch of strategy to have those deposits better stand out to sellers.
Editor's Note: Christopher Carter is NOT an attorney. He does not give legal advice. For interpretation and application to specific circumstances of anything you read in this article, you must speak with a Florida-Licensed attorney.
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