Earnest Money Contract: what it is, what it's for, and types

In Spain, an essential legal instrument for agreeing to the purchase and sale of a house is the earnest money contract. Here we will explain what it consists of, what this legal instrument must stipulate, how it works, examples of earnest money contracts that exist, etc.

We will also address what distinguishes this agreement from a reservation agreement, why it is mandatory, where and how payment is made, and its duration. So be sure to read until the end; you're sure to find it interesting.

What is this contract and what is its purpose?

In short, it is a private agreement made by two parties interested in negotiating a subsidized housing unit or any other property. It's a type of preliminary commitment prior to the specific signing of the purchase and sale, where one party pays the other a percentage of the agreed amount. 

This agreement is entered into for several reasons, such as:

• The buyer is applying for financing from a financial institution.
• The seller must pay off the mortgage, terminate a rental agreement, or register a document to hold title to the property. 
• Because it is a new build house and construction has not finished. 

How do earnest money contracts work?

From what has been explained, we can infer that this housing reservation agreement operates to protect those who are negotiating. The buyer guarantees that they will not sell the property to third parties. The seller is protected against the buyer's withdrawal, retaining the earnest money as compensation for any inconvenience or damages that may have been caused.

Types of Earnest Money Contracts

Those who are negotiating should know that there are several types of earnest money agreements, and each has its own characteristics and different legal implications.

Depending on your case, you should consult which of these three types suits your situation.

Confirming Earnest Money

Its purpose is to reaffirm the parties' commitment to finalize the purchase-sale negotiation, thus representing an advance payment of the agreed price. This agreement is made exclusively when there is a firm conviction to proceed with the negotiation, and neither party can unilaterally withdraw from it. 

Penalty Earnest Money

This agreement aims to establish a financial penalty for non-compliance by the negotiators, implementing different legal consequences for whoever withdraws from the purchase-sale. If the buyer withdraws, they will lose the amount advanced, and if the seller fails to fulfill the agreement, they will refund the amount received plus an agreed-upon sum.

Penitential Earnest Money or Right to Withdraw

This is the most flexible agreement and allows either negotiator to unilaterally withdraw from the pact if they deem it appropriate for their interests. It is common for negotiators or parties to agree on an amount as a penalty in the event of not wishing to continue with the negotiation.

Differences or discrepancies between an earnest money agreement and a reservation agreement

Expert professionals agree that the discrepancy lies in: 

The legal effects 

They are for the negotiators, should the need arise to revoke the contract. 

Earnest money is regulated 

Specifically contained in the Civil Code

Reservation agreements are not 

They are definitely not provided for in the Civil Code.

The reservation agreement is binding 

They must comply, unless they have agreed otherwise regarding rescission.

What should an earnest money agreement include?

It is worth noting that an earnest money agreement should include, among other requirements, the following:

• Parties' details: names, surnames, ID number (DNI), etc.
• Description of the property subject to the purchase-sale, such as: location, registration information, certificate of occupancy, mention of any encumbrances on the property.
• Purchase price and payment method. 
• Specification of amounts paid by the parties.
• Price of the earnest money contract, given to the owner for signature, stating that it will be deducted from the final price.
• Timeframe for signing the purchase agreement.
• The type of earnest money agreement being signed, and its expiration date.
• Signatures of the negotiators.
• How the property will be delivered.

How much money needs to be paid with this contract?

The payment of the amount specified in the earnest money agreement is always the buyer's responsibility, considered a "token" of their intent to negotiate. The percentage to be paid can range from 5% to 15% of the agreed price, but 10% is the most common. 

It must be clear that as soon as the purchase agreement is formalized, the amount paid as earnest money must be deducted at the end of the negotiation.

How and where is the earnest money paid?

As this is a private agreement, the parties can agree on the method and location for making or receiving the earnest money payment. Here are the different methods:

• Earnest money payment in cash
• Earnest money payment by bank transfer
• Earnest money payment by check

Who keeps this money?

In the case of penal earnest money, the capital disbursed serves as a guarantee for compliance with the agreement. If the buyer breaches it, they lose that capital. And if the seller withdraws, they must refund double the earnest money or more, as agreed.

How long can an earnest money contract last?

In each earnest money agreement, the term that the negotiators or parties deem appropriate is agreed upon, but you should remember that the law establishes a maximum period. This period for transferring the property, after signing the earnest money agreement, is six months.

Can this agreement be extended?

We must emphasize that this is a private agreement, and nothing obliges the parties to sign an extension of that contract. If an extension is made, an addendum must be included. This addendum must specify the new term agreed upon by the negotiators for the final signing.

When are earnest money agreements not valid?

There are several scenarios that could render an earnest money contract invalid, let's look at some of them:

• When there are multiple owners, and only one of them signs
• When the amount of the earnest money is not established
• When the period for the final signing is not defined
• When the regulations of the Civil Code are not observed

Can a breach of an earnest money agreement be claimed?

The answer is yes. For example, if the buyer refuses to comply with what was agreed upon, the seller can resort to legal action. The seller can also request the signing of the negotiation and demand payment of the earnest money as fair compensation for the damages caused.

What happens to the agreement if I don't get the mortgage?

If the earnest money agreement was signed and financing is not secured, that money will be lost, as the agreement will be breached. However, the purchase agreement could contain a provision stating that, in the event of a default, the parties are exempt from paying earnest money.

What should be considered before signing an earnest money agreement?

There are many elements to review, so it's important to seek professional advice, but in its absence, you should confirm that:

The agreement complies with the regulations of the Civil Code

The involved parties are those who should be present

There is no overreach in the wording, such as adding illegal clauses

Earnest Money Contract Template 2024

Solely for the purpose of generally illustrating how an earnest money agreement should be drafted, we provide a sample template.

In ________, on _______ of _______  of ____

The Parties

On the one hand, Mr./Ms. __________________________, of legal age, of __________ nationality, with National ID No. __________, and residing at __________ street _____, No. ______ Hereinafter, THE SELLER. 

On the other hand, Mr./Ms. __________________________, of legal age, of __________ nationality, with National ID No. __________, and residing at __________ street _____, No. ______ Hereinafter, THE BUYER. 

Recitals

That Mr./Ms. ______________________________ is the owner with full title of the property ____________________, as stated in deed ____________________, registered in the Property Registry No.____ of ________, in ______________ with cadastral reference No. _______, its area is __________ built square meters and __________ usable square meters, with a share of ________ in the common elements, and includes an attached garage space, located in a community-regime building, regulated by the Horizontal Property Law. 

That, Mr./Ms. _________________________ being interested in the acquisition of the aforementioned property, the parties sign this EARNEST MONEY CONTRACT, with the following clauses:

FIRST. Mr./Ms. ____________________ undertakes to sell the described property, free of encumbrances and leases, being up to date with the payment of community expenses, as well as taxes, fees, and contributions, whether regional or municipal, and Mr./Ms. ____________________ undertakes to buy the described property. 

SECOND. The parties agree on the total purchase price of ________________ euros.

THIRD. Mr./Ms. ________________________ delivers to Mr./Ms. _________________ the amount of ___________________ euros as earnest money, granting a receipt for payment through this document for the purposes of Article 1454 of the Civil Code.

FOURTH. Should the buyer breach what is agreed in this contract, they shall forfeit the amount delivered as earnest money. Should the seller breach what is agreed, they shall return double the amount.

FIFTH. Both parties undertake to execute a public purchase and sale deed within _______ months, at the notary chosen by the buyer.

SIXTH. Mr./Ms. ____________________ undertakes to pay the remaining amount, which totals _____________ euros. Likewise, Mr./Ms. __________________ undertakes to deliver possession and the keys to the property.

SEVENTH. The expenses and taxes for the execution of the public purchase and sale deed shall be borne by the buyer for the first and subsequent copies of the deed, those for the registration of the deed in the Property Registry, the payment of the Property Transfer Tax and the Stamp Duty derived from the purchase and sale deed. The seller shall pay the expenses of the original deed and the payment of the Tax on the Increase in Value of Urban Land.

EIGHTH. The parties agree to submit, as required by law, to the Courts of ________________.

In witness whereof, they sign and subscribe this document in duplicate, with a single legal effect, at the place and date indicated at the beginning.

Signed: Mr./Ms. ____________ Signed: Mr./Ms. ____________

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Conclusion

When selling or buying a property, that is, making a real estate investment, it is mandatory to sign an earnest money agreement, not just to secure the transaction as a seller. The buyer's position can also be protected with a well-drafted agreement, and Domoblock has the expertise for this.