What Is Good Faith Money?
Let me explain what good faith money is—it's essentially a deposit you, as a buyer, put into an account to demonstrate your genuine intention to follow through with a deal. This money often gets applied to the purchase price later on, but if the deal doesn't happen, it might not be refundable.
Key Takeaways
- Good faith money acts as a security deposit towards completing a purchase.
- This payment is usually nonrefundable but credited towards the final purchase price.
- When the seller wants to both qualify and motivate a buyer, the deposit amount asked for will be larger.
- Depending on the supply and demand, good faith money amounts can vary as a percentage of the final price.
- Both seller and buyer should specify good faith money terms in writing.
- Good faith money often acts as a strong motivator for a buyer to close the deal as it represents a possible sunk cost; the higher the cost, the more likely they are to go through with the purchase.
Understanding Good Faith Money
You might also hear good faith money referred to as earnest money, and it functions much like a security deposit on a rental property. While a security deposit for something like a home, vehicle, or equipment covers potential damages, good faith money protects the seller against the lost opportunity if you, the buyer, back out of the purchase.
In most scenarios, the deposit is a percentage of the total amount owed—smaller for big-ticket items like houses or leases, and larger for smaller, consumable purchases. A typical example is the earnest money escrow deposit that home sellers require to enter a sales contract with you as the buyer.
Good Faith Money Amounts
The amount of good faith money needed to start a contract with a seller can vary a lot, depending on the asset, the local market, and how credible you appear as a buyer. For instance, in a hot housing market where multiple offers come in on the same properties, the expected earnest money deposit might exceed the usual 1% to 3% of the home's potential purchase price.
In pricey neighborhoods, this can add up to a significant sum, giving you much more incentive to just go ahead with the purchase instead of dragging your feet on financing. This process weeds out buyers without ready financing, favoring those with solid financial standing.
Good Faith Money as Motivation
This setup shows how the money, while meant to cover the seller's opportunity cost of not dealing with another buyer, allows sellers in high-demand markets to demand more earnest money, forcing you to decide quickly.
It also introduces a sunk-cost bias that can help you push past any buyer's remorse if you've overbid. In any case, a large earnest money requirement benefits the seller and signals that you might be paying a premium for the property. If you're aiming for a smart buy, consider this a red flag to walk away.
Most good faith money deposits come with an agreement outlining when you might lose the deposit if you're unable or unwilling to complete the contract. As a buyer, you need this written agreement to ensure the deposit applies to the purchase.
You can sometimes recover your good faith money based on the agreement's terms—for example, if a professional home inspection fails, that's usually a valid reason to get it back.
A good faith deposit resembles a call option in that it gives you the right to complete the purchase, but unlike an option premium, it's typically applied to the final price rather than being non-applicable.
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