(update: as of 5/10/2015, this entire article still applies exactly as it did when originally written - Chad H)
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 debt 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 always 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.
We 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. and contact us directly if you'd like more information.