Key Takeaways
- Commitment Assurance: Good faith money serves as a security deposit to solidify a buyer’s intent.
- Nonrefundable Nature: Generally nonrefundable but credited towards the final purchase, motivating the buyer to proceed.
- Seller’s Motivation Strategy: Larger deposits can be requested to qualify and encourage serious buyers.
- Variable Amounts: Depending on market dynamics, good faith money can vary as a percentage of the final price.
- Written Agreement: Terms for good faith money should always be explicitly outlined in writing to protect both parties.
- Buyer Incentive: Acts as a sunk cost, encouraging buyers to finalize the deal to avoid losing the deposit.
Understanding Good Faith Money
Good faith money, also known as earnest money, resembles a security deposit in rental agreements. While a security deposit may cover potential damages, good faith money protects the seller from missed opportunities if the buyer fails to complete the purchase.
Typically, the deposit is a percentage of the total amount—a small percentage for large transactions like real estate and a larger percentage for smaller, more consumable items. An example is the earnest money deposit required in many home sales contracts to secure an agreement between buyer and seller.
Good Faith Money Amounts
The deposit required varies based on the asset, market conditions, and the buyer’s credibility. For instance, in highly competitive housing markets, earnest money deposits can skyrocket beyond the standard 1%-3% of the home’s purchase price. Such significant amounts motivate financially stable buyers to secure financing quickly and deter less prepared buyers.
Good Faith Money as Motivation
Though the earnest money compensates the seller for lost opportunities, it also pushes buyers towards a prompt decision. High demand allows sellers to demand more earnest money, creating a sunk-cost bias where buyers proceed to avoid forfeiting the deposit.
Good faith deposits are typically part of a written agreement outlining circumstances where the buyer could lose the deposit. This protects both parties and often stipulates conditions under which the deposit can be refunded, such as a failing home inspection.
Unlike call options where the premium isn’t applied to the purchase price, good faith money generally counts towards the final sum. This ensures that while the buyer secures the right to complete the purchase, the money isn’t lost but instead applied to it.
Related Terms: Security Deposit, Earnest Money, Escrow, Sunk Cost, Call Option.
References
- Rocket Mortgage. “Earnest Money: What Is It And How Much Is Enough?”
