If it’s been a while since you bought a home, the due diligence period is something you need to make sure you understand.
When it first came about there was a lot of confusion about whom it benefits but it worked out well in many states before North Carolina adopted it. When North Carolina agents started using it, a hundred dollars due diligence fee wasn’t unusual, even though, when you think about it, it doesn’t put much at risk.
Like most agents it took me a little while to grasp its utility. However, someone finally explained to me that the concept is borrowed from the commercial real estate world where it has long been common. Essentially, you as the buyer are purchasing an option to buy a property at a certain price for a period specified in the contract.
As part of the standard residential real estate contract, you specify both the fee and the length of time for the due diligence period. The contract also specifies other variables including price, earnest money, closing date, etc.
Here are some important points to remember about due diligence.
- Both the length and amount are negotiable. There are no standard fees or lengths. And there are strategies that both buyers and sellers can employ to make the due diligence period work for them.
- It is considered an option because during the due diligence period, the buyers can withdraw from the contract without penalty even though that privilege is not extended to the seller. The buyers don’t get the due diligence fee back, however. That freedom to withdraw is what the buyer is paying for. For that reason, the due diligence fee is paid directly to the seller when the offer becomes a contract with everybody’s signatures. It is not held in trust like earnest money and the seller can spend it immediately. The good news is that the amount of the fee is credited towards the purchase of the home if the sale goes through.
- The due diligence period is generally used by the buyer to do inspections and line up financing. However, the contract is quite explicit that the buyer can withdraw for “any or no reason.” They don’t even have to state their reason. The buyers could even put multiple homes under contract, do their inspections or just noodle on it, until they decide which one to buy. The cost to them is the due diligence fee paid to the seller of the home they didn’t buy.
- During the due diligence period the home can be shown and marketed but the sellers cannot accept another offer. In practical terms though, showing activity on homes in due diligence drops off dramatically. However, an attractive home in a hot neighborhood can still attract and accept backup offers that only go into effect when the first contract is terminated.
- There really is no point in requiring earnest money before the end of due diligence and the standard contract makes it easy to specify what is agreed to initially and at some later date. As the listing agent I like to see more of a due diligence fee and then I can be indifferent to what the earnest money is. Why? Because by the time a buyer has paid a substantial due diligence fee, and paid for inspections and an appraisal, they are already walking away from a significant amount of money and should be pretty committed to closing the deal, although every situation is a little different.
- There are agents that still don’t think that the due diligence provisions in the standard contract are an improvement over the old repair negotiations. You don’t have to have either the due diligence fee or the due diligence period written into the contract but the standard contract no longer has the inspection clause.
Using Due Diligence to Improve Your Offer
In a market like today’s, how does a buyer use the due diligence fee to nail down a purchase without bidding up the price?
From a seller’s point of view, the higher the fee and the shorter the length of due diligence the better. This can give one buyer a significant advantage over another buyer. Be careful using this strategy, however. The seller is looking at it as an indication of your commitment to purchasing the home. If you are not committed, you could be in for a nasty surprise. You can feel more comfortable if there has been a pre-inspection by the seller and documentation of repairs. A well documented disclosure form helps too but it is not part of the contract and won’t get your due diligence fee back if the seller wasn’t aware of something. Older homes are more likely to have issues than newer ones.
Also keep in mind that you are not only buying a home you’re buying into a neighborhood. If you discover that the crime rate in the neighborhood is higher than you can tolerate, you can back out during due diligence but this is something you can easily check before you plunk down that due diligence fee that you will not get back, even if the math teacher next door is cooking up meth in the RV parked in his driveway.
Other things can make one offer better than another even at the same price. A cash buyer can be better than someone that has to finance 97% of the price or is asking for the seller to pay a significant amount of their closing costs. When they plan to close can also be a significant factor in deciding. Usually, but not always, sooner is better.
Buying a home can be complicated and often involves coordinating a lot of moving parts. I agree that it really shouldn’t be and there may even be some trends developing to make it simpler but I probably will be long gone before that comes about. In the meantime, the expertise of an experienced real estate agent is worth the (negotiable) price you pay.