Earnest Money, Advance Payment & Penalty Differences

Before buying a property, the very first major financial step in almost every case is paying some amount to the seller. In my experience, most clients use the terms earnest money (foglaló), advance payment (előleg), and penalty (kötbér) as synonyms, even though their legal and financial consequences are light-years apart. Due to a hastily handed-over sum or a poorly drafted contractual clause, the parties can lose millions of Forints if the transaction fails to close. As an attorney, my goal is to incorporate safeguards into contracts that precisely match your interests, avoiding subsequent disputes and losses.

What Does the Civil Code Say About Earnest Money, Advance Payments, and Penalties?

Earnest Money as the Strongest Safeguard

Earnest money is the strongest safeguard for the performance of a purchase agreement, regulated under Hungarian law by Section 6:185 of the Hungarian Civil Code (Ptk.). If the contract fails to close due to the buyer's fault, the buyer loses the earnest money paid. Conversely, if the sale does not occur due to the seller's fault, the seller is obliged to refund double the earnest money received. In my practice, the amount of earnest money is usually set at 10% of the purchase price. I must emphasize that the legal consequences of earnest money derive directly from the law, meaning that upon contract termination, the sanctions apply automatically without requiring judicial proof of actual damages.

The Advance Payment as a Simple Purchase Price Installment

Many are surprised when I explain that an advance payment has no penal character under Hungarian law. An advance payment is simply a pre-paid portion of the purchase price. If the contract is ultimately not concluded – regardless of which party was at fault – the full amount of the advance payment is refunded to the buyer. Naturally, the non-defaulting party can claim damages from the other party, but in this case, they must prove their actual damages resulting from the breach of contract before a court, which is a complex and uncertain process.

The Contractual Penalty as Punishment for Breach of Contract

A contractual penalty is an agreement in which the parties stipulate that if either of them breaches their obligations (for example, delays handover/possession or payment), they must pay a pre-determined sum to the other party. Under Section 6:186 of the Civil Code, proving actual damages is not required to enforce a penalty; the sum becomes due upon the mere fact of the breach of contract. However, it is important to be aware that if the stipulated penalty is disproportionately high, a court may reduce it upon the debtor's request.

Comparison of Practical Differences

Real Cases from My Practice: How the Sanctions Work

When the Buyer Does Not Obtain the Bank Loan

In one of my cases, the buyer paid HUF 2 million in earnest money upon signing the contract, but the bank eventually rejected the loan application. Since we had not explicitly stipulated in the contract that the earnest money would be refunded in the event of a rejected loan, the buyer lost their money. This demonstrates how crucial it is to draft customized contracts that cover all circumstances.

When the Seller Receives a Better Offer

In another case, the seller received a significantly better purchase offer after signing the contract and withdrew from the original agreement. Since the buyer had paid HUF 3 million in earnest money, the seller had to pay back HUF 6 million. This penal burden ultimately protected the buyer from speculative seller behavior.

Delayed Handover and the Effectiveness of Penalties

On several occasions, the handover of newly built apartments was delayed. In the contracts I drafted, we stipulated a daily penalty for the duration of the delay. The builder could not escape the obligation, and the daily penalty amount successfully covered the buyers' rent and storage costs without requiring them to go to court.

Which Instrument Do I Recommend for You?

As a Buyer

If you are entirely certain of your intention to buy and have secure financial backing, earnest money is the best tool because it secures the property, and the seller will not easily back out. However, if your financing is uncertain (for example, you still need to sell your own property or your bank loan is unconfirmed), I recommend paying an advance payment instead, or that we stipulate escape clauses in the contract for the refund of the earnest money. To encourage compliance with the handover deadline, I highly recommend using a late performance penalty.

As a Seller

As a seller, your interest is that the buyer takes their intention to purchase seriously. Earnest money is the most suitable tool for this, as if the buyer changes their mind, the earnest money remains with you as compensation for the lost time and other missed prospects. I rarely recommend a simple advance payment to sellers on its own, as it does not represent a real commitment on the part of the buyer.

Frequently Asked Questions

Can the earnest money amount be higher than 10% of the purchase price?

Legally, there is no obstacle, but according to Hungarian judicial practice, if the earnest money is excessively high (for example, reaching 20-30%), a court may reduce it upon the debtor's request. Therefore, I recommend sticking to the safe, generally accepted 10% level.

Is it enough to just write "earnest money" (foglaló) in the contract, or must it be specifically justified?

Under the Civil Code, it must clearly follow from the contract that the handed-over sum is earnest money. If the wording is inaccurate or ambiguous, in the event of a dispute, a court will treat the sum as an advance payment, which eliminates the penal character of the earnest money. Therefore, precise legal drafting is essential.

Should the earnest money be transferred directly to the seller, or should it go into an attorney's escrow?

Both solutions are common. From a safety perspective – especially if the property is encumbered or the seller is a foreign national – I recommend transferring the funds to an attorney's escrow account, from which I will forward the sum to the seller only after the necessary conditions are verified.

How Can I Assist You?

During real estate transactions, choosing the correct financial safeguards determines the security of the entire transaction. In my office, we do not use template agreements: in every case, we define the roles of earnest money, advance payment, and penalties tailored to your specific life situation and risks.

Protect your money from legal traps! Request a consultation from my office, and we will help you develop the safest contractual structure. Get in touch with me!