Design Process
How to Sign an Earnest Money Contract for Land?
The process of searching for, selecting, and purchasing a plot of land is one of the most important steps in building a house. After deciding on the right plot, it’s time to begin the purchase procedures, which can extend for a few weeks or several months.
When purchasing land, there are typically two phases of financial outlay: on the one hand, the reservation or deposit, which is formalized in the earnest money contract, and on the other hand, the signing of the effective purchase and payment of the remaining balance at the time of signing the property deeds before a notary.
While it is advisable to be advised throughout the entire process by a lawyer specializing in real estate and land transactions, it is true that the first step, signing an earnest money contract, is a private agreement between seller and buyer. It acts as a particular contract involving a significant amount of money, and it is important to have it well-defined.
Let’s look in detail at what an earnest money contract consists of and its purpose.
#1 What does it consist of? It is a private contract signed by the buyer and seller of a plot of land or property.
#2 What is the purpose of signing an earnest money contract? Signing an earnest money contract allows you to reserve the right to purchase the property you are interested in, thereby providing a timeframe for administrative, legal procedures, or for arranging mortgages and liquidity with banks or on a personal level. It acts as a deposit for reserving a plot of land.
#3 How is it made effective? To sign an earnest money contract, the buyer must pay the seller a mutually agreed-upon amount as a deposit. This ensures the reservation of the land, with a penalty applied to the party that breaches the agreement.
#4 What are the implications of signing an earnest money contract for land? It is important to remember that an earnest money contract is a private agreement between seller and buyer, so the conditions it includes, as well as the consequences of its breach, are entirely open to changes and modifications.
The implications of signing an earnest money contract depend on the agreement we negotiate with the land seller or their intermediary (real estate agency, property agent, etc.), so it is important to be well-advised to negotiate conditions that suit our needs and that we can fulfill without problems.
Key Aspects of an Earnest Money Contract: Time and Money
Whether we are considering signing an earnest money contract for land as sellers or as buyers, it is important to remember that, as with any private agreement, the key is for both parties to be satisfied with the agreement.
Basically, the two key aspects of an earnest money contract are the timeframe and the amount to be paid.
The timeframe. Generally, a maximum period of between 2 and 6 months is defined between the signing of the earnest money contract and the definitive purchase of the land. This period is always negotiable, so it is important to assess the buyer’s ability to secure the necessary liquidity for the purchase.
Sometimes the purchase of land depends on the positive granting of a mortgage; this must be in writing, as otherwise, if the mortgage were not granted to the buyer, they would lose the deposit money.
The amount. The second factor to consider is the amount of the deposit. Generally, it is agreed to be between 10% and 20%, but there are many agreement formulas, and it depends on each particular case.
We have encountered cases where the buyer, before signing an earnest money contract, must negotiate with the bank to secure financing. In this regard, it will be important to know how much money we have saved and how much the bank will lend us.
We must bear in mind that a bank does not usually lend money to buy land, unless we provide a very high amount of liquidity. However, some banks do provide financing for land + house, but in this case, they will request an architectural project with a building permit to grant financing for the land portion.
As you can see, there are many factors that can vary our purchase strategy and, consequently, the points of the agreement for signing an earnest money contract for land. In this regard, we recommend that you seek advice to clarify all the implications of each decision.
In fact, at the office, we always recommend that you come to see us before making any purchase decision, as this allows us to review that all urban planning and legal matters are in order, in addition to advising you on the purchase strategy.
From here, if everything is clear and you are going ahead with the land purchase, let’s look at what signing an earnest money contract entails, step by step.
What Information Does an Earnest Money Contract Contain?
Personal data. The earnest money contract must include both your personal information and that of the person or company selling you the property.
Caution! The purchase price will vary depending on whether the land is owned by a company or an individual. If the land is owned by a company, we must pay 21% VAT; if the land is owned by an individual, we must pay the Property Transfer Tax, which is 8%. We can find this out by requesting a simple note from the property registry for the land; there are many companies that process this for very little money within 24 hours.
Regarding who must sign the earnest money contract, it is important to note that if the buyers are a married couple under a community property regime, it will be sufficient for one of the spouses to sign. However, if you are a married couple under a separation of assets regime or are not married, both spouses must sign.
Property identification. It is very important that the contract defines the property you wish to purchase; the key piece of information will be the cadastral reference.
Additionally, when signing an earnest money contract for land, you can provide some additional data, such as the address, square meters, or applicable building regulations.
Final price and payment method. An essential aspect of signing an earnest money contract for land is to set a final purchase price and the payment method.
This way, you will ensure that the land for which you are leaving a deposit will not increase in price within the timeframe you need to formalize its definitive purchase.
Economic amount to be paid in the earnest money contract. In this case, it is necessary to specify the exact amount to be paid at the time of signing the earnest money contract, making it very clear that this amount will be deducted from the final price of the land at the time of signing the definitive purchase.
The disbursement of this amount can be made via check at the time of signing or via transfer after signing the contract. In any case, the contract must include a clause indicating that the contract will not take effect until the deposit is made into the seller’s account.
Deadline for formalizing the sale. Find a maximum timeframe that is comfortable for you and within which you feel capable of managing the land purchase. It is important that both parties agree on the agreed-upon deadline.
Possible property encumbrances. Another recommendation is to ensure that the property is free of debts, to avoid assuming them in the future. You can check the status of the property’s mortgages through the Property Registry or, as I mentioned, through an intermediary who can make the inquiry.
Distribution of purchase and sale expenses. And finally, let’s mention how the expenses derived from the purchase and sale of the land are usually distributed.
Normally, the seller covers the expenses of granting the public deed, and you, as buyers, should pay the expenses subsequent to the perfection of the purchase agreement, such as registration in the Property Registry and payment of the Property Transfer Tax or VAT.
This covers all the necessary information to include when signing an earnest money contract.
But what happens if the earnest money contract is broken?
Breach or Withdrawal from an Earnest Money Contract
What happens if one of the parties changes their mind? What happens if the buyer cannot secure the necessary financing within the agreed timeframe?
First of all, it is important to remember that an earnest money contract is a private agreement between two parties. If there is goodwill, small delays or setbacks can always be accommodated if both parties wish to maintain the initial agreement.
But it is also important to remember that it is a contract that involves penalties, and if one of the parties breaches what was agreed, the other party is fully entitled to implement the agreed-upon penalties.
Generally, it is agreed that if the buyer decides not to proceed with the land purchase, they lose the deposit. This is a way to financially commit them; otherwise, there would be no point in signing an earnest money contract to buy land.
In the case of the seller, a penalty is also usually agreed upon, which amounts to double the deposit in case of withdrawal.
As you can see, the implications of contract breach are very serious and entail the loss of a very significant amount of money. We must remember that an earnest money contract can represent between 10% and 20% of the total cost of the land.
The so-called hidden defects in an earnest money contract
When signing an earnest money contract for land, anomalies, known as hidden defects or flaws, might appear in the process.
For a hidden defect to exist, it must, on the one hand, not be a visible defect that you could have noticed from the beginning, and it must have existed prior to the signing of the earnest money contract.
An example would be the purchase of stable land that later turns out to have a very unstable composition, or acquiring a plot in perfect condition and subsequently discovering that it is affected by some urban planning scheme, thus complicating its construction.
These defects, to be considered hidden defects, must also be serious defects identified within 6 months from the signing of the contract.
In this case, the buyer can recover the full economic amount contributed.
As you can see, signing an earnest money contract can be very useful to ensure that we have effectively reserved the land we are interested in, but it is not a simple process nor one to be taken lightly, as it has significant economic and legal implications.
In this regard, as we always remind you, it is important to be well-advised, either by your architect, who will most likely refer you to a lawyer, or by an impartial intermediary real estate agency.
In any case, the most important thing is that you understand each point you sign perfectly and comprehend the implications of non-compliance.
It is also important that you are clear on how you will obtain the remaining liquidity for the land purchase and, if it depends on a mortgage being granted by a bank, that you have negotiated the conditions with the bank beforehand.