What Is Good Faith Money?
Good faith money is adeposit of money into an account by a buyer to show that they have the intention of completing a deal. Good faith money is often later applied to the purchase but may be non-refundable if the deal does not go through.
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
Good faith money can also be known as earnest money and acts similar to a security deposit on a rental property. Where a security deposit for a rental home, vehicle, or equipment may be taken as insurance against damages, good faith money is usually taken as insurance against a lost opportunity should the buyer not go through with completing a purchase.
In most cases, the deposit amount will be a percentage of the total amount owed—a small percentage for something large like a house or lease contract, and a larger percentage for smaller purchases of consumable items. A common example of good faith money is the so-called "earnest money"escrow deposit required by most home sellers to enter into a sales contract with a buyer.
Good Faith Money Amounts
The amount of good faith money used to initiate a contract with a seller will vary considerably depending on the asset, the local market, and the credibility of the buyer. For example, when the housing market in a given locale is very hot and multiple buyers make offers on the same properties, the expected earnest money deposit, in some areas, can rise higher than the standard 1% to 3% of the potential purchase price of the home.
In expensive neighborhoods, this can be such a substantial amount that the buyer has much more incentive to merely make the purchase, rather than delay while working out financing. Those buyers who do not have financing available already are thus weeded out in favor of buyers with stronger financial footing.
Good Faith Money as Motivation
This phenomenon reflects the fact that although the money is ostensibly for the seller to offset the opportunity cost of doing business with a different buyer, the higher demand allows the seller to command more earnest money, pushing the buyer to quickly make a decision right away.
This also creates a sunk-cost bias in the buyers that may help them get past their buyer's remorse if they bid up the property too high. Either way, a large earnest money requirement works in favor of the seller and should be a bit of a warning sign that they are about to pay an extra premium for the property. For someone who is looking to make a shrewd purchase, this would be a warning sign to let the property go.
Most good faith money deposits are part of an agreement that spells out the conditions under which a buyer may lose their deposit if they are unable or unwilling to complete the contract. The written agreement is important for the buyer to ensure that the deposit will actually go towards the purchase.
The potential buyer can sometimes get their good faith money back depending on the terms of the agreement. For example, if the home fails a home inspection by a professional, it is usually a fair and justifiable reason to get the good faith money back.
A good faith deposit may seem a little like a call option because the buyer has the right to complete the ultimate purchase. However, unlike an option, good faith money is usually applied to the final purchase price, while a call option premium is not.
FAQs
Good faith money is a deposit of money into an account by a buyer to show that they have the intention of completing a deal. Good faith money is often later applied to the purchase but may be non-refundable if the deal does not go through.
What is earnest money used for? ›
When you find a home and enter into a purchase contract, the seller may withdraw the house from the market. Earnest money, or good faith deposit, is a sum of money you put down to demonstrate your seriousness about buying a home. In most cases, earnest money acts as a deposit on the property you're looking to buy.
How to avoid paying earnest money? ›
You can include it in the offer, or you can state that you'll place it in escrow several days after an accepted offer. If you use the latter approach, you can make offers on a dozen properties without paying a single earnest money deposit.
Who keeps earnest money if a deal falls through? ›
The purpose of earnest money is to provide the seller with compensation in the event that the buyer backs out of the deal through no fault of the seller and in violation of the agreements in the purchase contract. If that happens, the seller gets to keep the earnest money.
Do you lose earnest money if a loan is not approved? ›
Buyers can include a financing contingency in their purchase contract, potentially allowing them to back out of a deal, and have their earnest money refunded, if financing cannot be secured.
Should I walk away from earnest money? ›
It depends on how far along your deal was. If you back out before a contract was signed, there are likely to be no consequences. If you already had a signed purchase agreement, though, you could potentially lose your earnest money deposit or even be sued.
Why would a seller want more earnest money? ›
Sellers tend to favor these good faith deposits because they want to ensure that the sale won't fall through. Earnest money can act as added insurance for both parties in the transaction. Earnest money could also lower the amount you need at closing because it's applied directly to your down payment or closing costs.
Do I lose earnest money if I back out? ›
Backing out without a contingency
If you don't have a contingency to protect you if that happens, you'll most likely lose your earnest money deposit and, in some cases, be subject to other penalties, however. If you back out for any reason and are not covered by a contingency, you'll most likely lose your deposit.
What happens to earnest money if a buyer cancels? ›
The earnest money typically goes towards the buyer's down payment or closing costs. It is refunded to the buyer only upon certain contingencies specified in the contract. If the buyer cancels the contract outside of the contingencies, it is released to the seller.
What happens if the buyer doesn't pay earnest money? ›
Even if the seller doesn't pursue legal action should you not pay earnest money following an agreement to do so, they'll almost certainly terminate the purchase contract. This will, of course, mean you lose the right to purchase the property, allowing other interested parties to come forward and stake their claim.
It's held in escrow as a show of good faith that you're interested in purchasing the home. If your bid wins, your earnest money is deducted from the amount you owe at closing. If the seller rejects your offer, your earnest money should be returned.
Can I skip a payment with earnest? ›
Earnest clients may skip one payment every 12 months. Your first request to skip a payment can be made once you've made at least 6 months of consecutive on-time payments, and your loan is in good standing. The interest accrued during the skipped month will result in an increase in your remaining minimum payment.
How much do sellers usually come down on a house? ›
The amount you may want to reduce your home's asking price depends on many factors, including the median price in your area, what comparable homes nearby are selling for and the length of time the home has been on the market. According to a Zillow study, the average price cut is 2.9 percent of the list price.
Is earnest money refundable? ›
The good news for buyers is in most situations, as long as a buyer acts in good faith, earnest money is refundable. As long as any contract agreements are not broken or decision deadlines are met, buyers usually get their earnest money back.
Can you borrow money for earnest money? ›
Can you borrow earnest money? It is not common or recommended to get a personal loan for an earnest money deposit. Besides enticing the seller, a good faith deposit shows a lender you are financially prepared for a mortgage. If you're concerned about coming up with earnest money for a house, it could raise a flag.
Is earnest money a write off? ›
If you lost earnest money due to a failed personal home purchase, you cannot claim the loss on your return. If you lost earnest money due to a failed business purchase of a rental home, you may claim the loss. The loss would be considered a capital loss you would write off on your Schedule D.
What is the difference between earnest money deposit and security deposit? ›
1. EMD: Applied toward the property purchase or refunded if the sale falls through. 2. Security deposit: Held by the landlord, refundable to the tenant at the lease end, minus deductions for damages or unpaid rent.
