If you’re buying a house, you’ll want to get familiar with some real estate jargon. And while many terms may not impact you much, others are of particular importance, like “deposits” and “down payments.”
Many newbie homebuyers may assume that these terms are just different words for the same thing, but they’re not. There are important differences between the two that all homebuyers should be aware of.
Let’s take a closer look at deposits and down payments to see how they compare, and how they differ.
A house deposit is a lump sum of money offered upfront along with an offer to buy a home. Deposits are typically required from buyers to show that they’re interested in purchasing a home and promise to follow through with the deal.
The deposit also shows the seller that the buyer has the financial means to buy the home. The deposit goes towards the down payment of a home once the deal closes.
When you find a house that you want to buy and put in an offer, you’ll have to include the deposit amount in the purchase agreement. This is one of many components that the seller will look over to assess the strength of the offer.
Depending on the climate of the market and the exact location in which you’re buying, you may have to bring a deposit cheque with you. Otherwise, the deposit cheque will have to be dropped off at the listing agency within 24 hours of offer acceptance.
Once the deal closes, the deposit will become part of the down payment and will go towards the purchase price of your home. For instance, let’s say you plan to make a down payment of $50,000 and offer up an initial $15,000 as your deposit. Once the deal closes, that $15,000 will be applied to your down payment, so you’ll need to come up with another $35,000 when you secure a mortgage to finance your purchase.
Keep in mind that if the deal falls through because of some form of breach of contract on your part, you may risk losing that deposit.
Home deposits are usually at least 5% of the purchase price of the home, though they could be bigger depending on where you’re buying. The higher the deposit, the more attractive your offer will be. And if you’re in the midst of a bidding war, going in with a hefty deposit might be required to make your offer stand out.
While the seller will be able to keep the deposit, it doesn’t go to the seller right away. Instead, the funds will be held in trust by the seller’s real estate brokerage. Home deposits are usually in the form of a certified cheque, bank draft, or money order. While your deposit is held in trust, it will accumulate interest.
A down payment is a lump sum of money that is paid upfront when taking out a mortgage to buy a home. Your deposit goes towards your down payment, which is due when your mortgage closes.
Down payments are usually expressed as a percentage of the purchase price of a home. So, if you were to make a 10% down payment towards a home that you’re paying $500,000 for, your down payment amount would be $50,000.
The amount of your down payment will depend on a number of factors, including the following:
Generally speaking, you’ll need to put down at least 5% of the purchase price of the home. More specifically, the following down payments will be required based on the home price:
It’s important to note that down payments less than 20% of the purchase price of a home will require mortgage default insurance. Also referred to as CMHC insurance, mortgage default insurance protects the lender, though premiums are paid by the borrower.
Smaller down payments mean more risk to the lender, as a higher loan amount will be required. And because of this increased risk, the lender will need to be appropriately covered.
The higher the down payment, the better, for many reasons. For starters, it will mean lower monthly mortgage payments and less debt overall.
In addition, a higher down payment can also help you qualify for a better mortgage interest rate because you’re less of a risk in the eyes of your lender. Finally, a higher down payment amount can help you avoid mortgage default insurance, which can help you save every month.
While the deposit must be paid upon offer acceptance, the down payment doesn’t need to be paid until the closing date. Your lender will require the down payment when closing on the mortgage.
If a deal on a home purchase fails to close, your deposit and down payment will be affected differently.
If the deal to buy the home doesn’t close, your deposit could be at risk depending on the reason for the failed deal. If you include conditions in your offer — such as a home inspection or financing condition — you can back out of the deal without consequence if you notify the seller before the condition’s expiry date. But if you back out of the deal without any condition in place, or you failed to fulfill or waive the conditions before their respective expiry dates, the seller may be able to keep your deposit.
Keep in mind that while the sale was “conditional” — which means the conditions included in the purchase agreement either needed to be fulfilled or waived within a certain time period — the seller could have been showing the home to other prospective buyers.
When the deal falls through, they have to start over again, which means the seller missed out on all that time that they could have been marketing their home. The deposit may help provide them with some financial recourse in this situation.
In some cases, the situation may have to be ironed out in court when it comes to whether the seller can retain the deposit or whether the buyer can get their deposit money back when a house doesn’t close.
If the deal on the house doesn’t close, there will be no need for a mortgage. And with no mortgage, there’s no down payment required, either.
However, since the deposit goes towards your down payment, you’ll need to make up for this portion of the down payment if the seller has the right to keep it. If the deal doesn’t close and you lose your deposit, you’re essentially losing part of your down payment. This leaves you in a situation in which you’ll have to save up that money lost when it comes time to make an offer on another home.
Real estate vocabulary can be a bit confusing for buyers, especially first-time buyers. But it’s important to understand the terms used, especially important ones like deposits and down payments, as these terms may sometimes be confused with each other and used interchangeably. But they’re different, and it’s important to understand how and why they differ.
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Lisa has been working as a personal finance writer for more than a decade, creating unique content that helps to educate Canadian consumers in the realms of real estate, mortgages, investing and financial health. For years, she held her real estate license in Toronto, Ontario before giving it up to pursue writing within this realm and related niches. Lisa is very serious about smart money management and helping others do the same.
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