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Understanding due diligence and earnest money on the NC Offer to Purchase and Contract

In 2011, the North Carolina real estate commission introduced a revised Offer to Purchase and Contract (always seeking to protect consumers) and with that, a new term called “due diligence”.  Well, change doesn’t come easy for many folks and this new concept and contract didn’t come easy for many NC Realtors either.  However, once you understand it, it’s pretty cool and is definitely designed to protect both real estate buyers and sellers.

Prior to 2011, “earnest money” was the only money that was put up, up front.  Earnest money was put in place primarily to show “earnestness” from the buyer and to help compensate the seller for their lost time and opportunities (from other prospective buyers) if the buyer “flaked out” basically.  As long as everything went fine and the deal went to closing, the earnest money would be credited back to the buyer at closing and everyone was happy.  However, things didn’t always go smoothly and buyers and sellers were sometimes left out in the cold.  Let me explain…

See, the earnest money would be returned to the buyers if their financing fell through for any reason.  This could be due to the loss of their job, them going out and buying a car or furniture (on credit) at the last minute and throwing their deft to income ratios off, or even a mistake by their lender.  Now, this is where the big problems came for the sellers.  Their home had been off the market (while under contract) for 3 weeks-a couple/few months waiting for this deal to close and at the last minute the buyer’s financing could fall through and the seller would be left standing there with nothing to show but hardship, lost time, lost opportunities, etc.  And the buyer would be on their way…with their earnest money in hand.  You can probably imagine how devastating this could be to sellers.

On the flip side, sellers were not the only ones that could be hurt.  Buyers could also get their earnest money back if inspections had been done (the buyers cost), requests for repairs were given, and the seller refused to fix one or more things that were requested by the buyer.  Great for the buyer, right?  Well, not exactly.  See, while the buyer had a right to back out of the contract AND get their earnest money back, they were still left with lost time and were still responsible for the cost of the inspection ($350+), the cost of the lender ordered appraisal ($300+) if it had been ordered, survey if already done ($350+) and any other arrangements or incurred costs.  The buyer could “stick in there” and continue on but they’re left with one or more things that will eventually have to be fixed on their dime.

Well, to help remedy these situations and others, the NC real estate commission came up with a revised Offer to Purchase and Contract in 2011.  The new Offer still implemented earnest money but also introduced a “due diligence fee” and “due diligence period”.

The due diligence fee is an amount paid by the buyer directly to the seller that is theirs to keep, period.  If the deal closes, the buyer will have that amount credited back to them at closing but either way, that amount up front is the seller’s to keep.  In addition to the due diligence fee, there is an agreed upon due diligence period.  The DD fee allows the buyer to conduct  ”due diligence” at buyer’s expense (inspections, appraisals, review of documents, survey, financing, obtaining insurance, etc) within the due diligence period and gives them the right to back out for any reason whatsoever…whether they flake out, simply fall out of love with the home, their financing falls through, etc.  The kicker is that, if they’re going to back out of the contract for whatever reason, they need to do so prior to the end of the due diligence period.  Otherwise, they will not only have lost their due diligence fee but also their earnest money that was put up (and held in escrow) as well.  This is because with the new contract, there is no longer a financing contingency.  If the buyer backs out prior to the end of the DD date, they will at least get their earnest money back.

With the new contract, the buyer is given more freedom and the seller is protected from being left empty handed at the last minute if financing falls through.

Strategies, for dealing with and negotiating the due diligence fee, amount, and earnest money amount:

As a NC/SC buyers agent

When representing the buyer(s), I want the dd fee and earnest money amount to be as low as possible without insulting the seller or giving the appearance that we’re just floating around wasting people’s time.  The lower the amounts, the lower the risk of loss for my buyer.  In addition, I want the dd period to be extended out as far as possible.  The longer the period, the longer my buyer has to do his/her due diligence and feel comfortable that everything will be just fine with their loan, etc.

What if inspections are done and my buyer is responsible for the cost of those inspections and then the seller says “I’m not fixing anything so you can just take your earnest money and go”?  Well, because of this, I DON’T typically order inspections right away.  I might have inspections scheduled 2-3 weeks out so that if the seller does end up refusing to fix one or more things, at least they’ve got a few weeks invested of their home being off the market and might be more inclined to work with the buyer in terms of getting those things fixed/repaired instead of having to go through that all over again with another buyer.  In addition, this gives my buyer more buffer room to get comfortable that his/her financing will be secured.  Hopefully, they have a really good idea of the likelihood of their financing going through prior to having inspections, appraisal, and survey ordered.  If that’s the case, then they’ve only really lost the due diligence fee.

It’s very important to ALWAYS keep track of this dd date (I put it in my calender with reminder notifications).  If more time is needed, go back and try to negotiate a date extension with the seller (they’ll usually work with you if you’ve been proactive) PRIOR to the dd date ending.  Otherwise, you risk losing your earnest money.

Also, please note…prior to ever even submitting the initial offer for my buyer, I’ve already asked the listing agent many questions and probed the best I can.  I try to find out the sellers motivation for selling, what their situation is so that I can determine how eager they are, and have even asked the listing agent if they feel that the seller will be prepared for the repair requests that will likely be coming their way.  I do my own due diligence so to speak.

 

As the listing agent

When representing the seller, I want the dd fee and earnest money amount to be as high as possible.  This says to me that the buyer HAS some cash, is serious (earnest) about making this work, and is willing to risk higher amounts.  And of course, if something does happen, my seller will be compensated just a little bit better.  Also, I want the due diligence period to be as short as possible.  A shortened dd period gives me confidence in the buyer’s willingness and abilities to make things happen and it shortens the length of time that my seller’s home is off the market should the deal fall apart.

Please note…the greater the amount of dd fee, the longer dd period my seller might entertain.  The smaller the amount off dd fee, the quicker my seller will want to see the buyer conducting their due diligence.

 

I hope that this helps you understand due diligence a little better.  Please feel free to comment below if you have any questions, comments, strategies of your own to share, etc.

Chad Hendrix
owner/broker in charge of Hendrix Properties
704-737-4400

 

 

Comments (6)

  • Ray December 12, 2011 - 6:19 pm

    I found the information very informative. Thank you. I would realy appreciate it if you could answer a couple of quesitons for me.

    I am selling my house myself and a buyer’s agent and client came to my door. We agreed to a price, they listed no Due Diligece fee on the Offer To Purchase and had listed $1500 as Additional Earnest Money to be delivered at the end of the Due Diligence period. (No Earnest Money was listed) We negotiated and I said I wanted $500 Due Diligence Fee and okay $1000 additional Earnest Money. Anyway we have gone back and forth on some issues and then their realtor emailed me an Offer To Purchase(which listed the $500 Due Diligence Fee and said she would mail it to me. I signed the Offer To Purchase contract and faxed it back to her on Friday. (I know I should have gotten the Due Diligence money in my hand first, but did not.)

    My questions…What if she does not send me the Due Diligence money and her client decides to pulled out of the deal?
    Is the realtor required by law to make good on the Due Diligence fee?
    And lastly, since I have not received the money, do we have a binding contract and can I, as the seller, pulled out of the deal?
    Thank you for any assistance you may provide.

  • Chad Hendrix December 12, 2011 - 7:01 pm

    Hello Ray, thanks for the post. I’m glad that you found my article helpful.

    I’m not a Lawyer, don’t practice law, and won’t TELL you what the law is. But, I will tell you how I interpret the contract and what I BELIEVE would be the case in your situation.

    Per the contract under 1. i., it says that the due diligence fee is given to the seller WITH the contract. However, the lack of due diligence money being in the sellers hands on effective date of the contract probably does not make the contract VOID by that alone. I’ve had several deals where the buyers may drop the due diligence off the following day, directly into the sellers mail box a couple of days later, etc. Nowhere on the contract does it say, in regards to the earnest money being delivered to the seller, “time is of the essence”. If it did say that, it would mean that exactly. But the fact that it doesn’t say that probably allows a little lenience in terms of the actual delivery of the dd money…in my belief. And 9 times out of 10, that would probably be no big deal because both parties are fresh into this and wanting it to work. However, best practice IS to get the due diligence money in hand before ever signing the offer to purchase.

    But to answer your question, I wouldn’t be surprised if the seller (you in this case) still not having the earnest money in hand actually makes the contract VOID-ABLE. In other words, I would guess that you would be able to back out if you chose with no repercussions simply because the buyers have not yet delivered the due diligence fee to you yet. Once they deliver the due diligence money to you, per the writing in the contract, It would appear to me the contract is in full force but the fact that they still haven’t gotten it to you may give you the legal right to back out…that would be my understanding.

    Could the buyer back out of the deal prior to ever giving you the due diligence fee? Well, sure they could and that’s why you as the seller need to be very proactive about getting that in your hands (and depositing it). I don’t know, in your case, if you’d have a legal right to that money though after the fact. That would definitely be a question for an attorney but I would suggest simply not letting that happen. As the seller, you simply need to be REAL proactive about getting that money in hand. Ideally, it IS given to you along with the offer but if not, surely don’t let days or even a couple of weeks go by without getting it.

    I hope I’ve answered your questions, Ray. Again, I’m not a lawyer (it’s crazy that I should feel SUCH a need to keep reiterating that but I just gotta to protect myself) but feel free to contact one if you wish. The buyer for your home may have already lined up a closing attorney in which case you may consider contacting them (good chance they wouldn’t charge you anything since they’re already hired).

    Chad Hendrix

  • Ray December 12, 2011 - 8:34 pm

    Thank you. Hopefully everything will work out…but just in case…I appreciate the info and advice.
    Ray

  • Crissy May 23, 2012 - 6:40 pm

    Thank you for the info. I have bought many houses for many years but the due diligence is new to me. That being said, we recently made and offer on a home wiht $500 dd and $1000 earnest money. Two days from closing, we get info from Flood cert saying a corner of the home is in flood zone and would require flood insurance. Based on the new info, we decided to terminate the contract looking at resale problems in the future. I do understand dd and earnest money, but the seller specifically answered “no” to the flood zone question on the property disclosure, although they have being paying flood insurance for the past six years. Do we have the right to our earnest money and dd money (even if we’re past the dd period) d/t falsified info from the seller on the property disclosure?

  • Chad Hendrix May 23, 2012 - 7:14 pm

    Hello, Crissy. I hope you don’t mind my prefacing my “opinions” by saying that I’d advise you to consult with the closing attorney (or another) that you had lined up and your buyer’s agent as well of course. But since you asked, I’ll be happy to tell you what I think. If what you’re saying is accurate and true, it sounds like you MIGHT have a good argument for getting your due diligence fee and earnest money back. Go back to your contract and look at paragraph 8(l) (page 7 of the contract). If the seller is in breach of the contract by misrepresenting a major fact (intentional or not), they MAY be in breach and therefore, you MAY have an argument for getting both monies back. Just take a good look at that paragraph. Your buyer’s agent should have given you a copy of the contract a while ago. But outside of that, that whole due diligence thing is about doing your due diligence. Did anyone (such as your Realtor), before the due diligence period ended, do a simple check to see if the home was in or near a flood zone? You should be able to go to http://www.ncfloodmaps.com , click on “digital flood maps” at the top left in the navigation bar and then enter the subject address. If it’s in or against a flood zone, it should indicate as such. Did you have a buyers agent working for you or did you deal directly with the seller’s agent? Or was it a dual agency situation in which the listing agent represented both of you? If you ask me, ANY Realtor involved in that deal should have caught that simple but very important detail. Ask the closing attorney about that and see for sure if you actually do have any recourse. I hope this is at least a little helpful and I hope that you’ll let me know what happens so that I can continue learning as well. Good luck, Crissy. Chad

  • db February 10, 2013 - 11:47 pm

    Question….What if, after paying a due diligence fee of $500, the inspection reveals several things about the home that will be costly to repair ( new roof is needed, dampness/mold under the house, etc.) thus, we as buyers, in light of these negative findings, choose not to buy the home. Would we get our DD fee back if we are still inside the dd period?