A Closer Look at Earnest Money

Summary: Have you heard the term “earnest money” while talking to your realtor? This article discusses the definition of earnest money, as well as how to compute the amount. We will also look at how to protect yourself when you have agreed to the details of the contract.

Read time: 6 minutes.

What is Earnest Money

Earnest money or  "arras" is the payment made by a buyer to a seller to demonstrate their serious intent in acquiring a property for sale. Earnest money in real estate shows the buying capacity of the buyer to honor the agreement. Providing earnest money into the contract all but seals the transaction. The buyer is now legally bound to purchase the property, and the seller has agreed to the amount and the terms outlined in the agreement. The property is now on hold until all terms and conditions agreed upon by both seller and buyer have been met. Earnest money, in a way, provides the buyer with much-needed time to finance the remaining balance for the property.

 

Earnest money is considered part of the purchase price and should be deducted from the overall cost of the property.  Is earnest money refundable? If the buyer suddenly backs out from buying the property, according to the Civil Code of the Philippines, Article 1482 of Republic Act 386, the earnest money will no longer be refundable. A refund is only possible if the fault is with the seller not honoring the said agreement.

 

How to Determine the Required Earnest Money?

Determining the earnest money needed for purchase depends on both the buyer and seller. There is no fixed amount or certain percentage that sellers and buyers use.  You can write the offer with a thousand pesos deposit if you wish, and the agent will present this as your offer to the seller. But again, going back to the definition of earnest money, this shows how serious you are in buying the property, so offering a thousand pesos will surely automatically dim the chances of your offer being accepted.

Based on our experience, earnest money mostly depends on the amount involved in the sale. The earnest money percentage should be around 5 - 10% of the sale amount. But there can be cases where the earnest money can be about 50,000 to 100 000. Again, nothing is definite, as long as both the buyer and seller agree upon the amount.

 Another way of showing your intent in buying the property is by making a two-part earnest money deposit. This means that you make an offer of, let’s say, P50,000 in earnest money, but then make it clear to the seller that this will can increase to P100,000 or more. Overall, the amount depends on the terms the seller and buyer agree on or after conducting the necessary appraisal. This safeguards your money from being held up until you know that the seller is serious about selling it to you.

How To Protect Yourself

1.     Do your due diligence first before making the deposit.

Check it out with your broker so they can help you with doing some background checks on the seller and the property you are interested in. Their job is to make sure that you, as the buyer, are protected throughout the sale.

2.   Place it in writing.

Request to your broker that in the agreement, there should be a clause that specifies the earnest money as “liquidated damages” just in case there will be unforeseeable events that may affect your financial capacity to pay. This just means that if you need to default on the contract, the seller can’t ask for more than what you have already included as earnest money. Also, understand that you can no longer refund the earnest money if you do not complete the purchase. Your broker or agent should be able to help you how to state this in the agreement.

3.     Give your check to a third party and not give it directly to the seller.

If your agent has an escrow account, you can hand them the check and be protected at the same time. This secures your payment just in case you pull out of the offer because of financing concerns or any other reason that you have seen in the property (structural integrity of the property, termite infestation, and others) that you do not like. Having a third party hold on to the check also protects buyers from sellers cashing in before completing the transaction.

Earnest money plays a vital role in securing a property purchase. It shows the seller of your capacity to pay and incentivizes the seller to make the sale. Working on buying a property? Talk to your real estate broker today to know how much earnest money you need to close the deal.