The real estate world is full of terms that don’t make much sense to the everyday homeowner. Though a great real estate agent can help explain terminology and procedures, it’s still up to the homeowner to read their paperwork and make smart moves based on their current information.
Two terms that can pop up frequently in real estate are due diligence and earnest money, terms that any homeowner needs to know if they want the best purchase or sale experience. Let’s get in-depth on due diligence vs earnest money to explain what each is, what they have to do with your transaction, and how to use both to help secure your home purchase.
What is Due Diligence and Earnest Money?
The idea behind due diligence is to minimize risk on the buyers’ end and possibly bring the home purchase price down. The buyer is doing their due diligence to make sure the home doesn’t have any major issues and that the homeowner truly wants to purchase the home. Due diligence has an associated fee, which generally ranges from several hundred to a few thousand dollars.
Earnest money, also known as an earnest money deposit, is similar to due diligence, but is less about potential buyers doing their homework and more about “show me the money.” Earnest money is a payment made to home sellers to demonstrate a strong interest in a potential home. With earnest money homeowners aren’t only telling you they really want the house with a pinky promise but instead literally putting money on the table. Earnest money deposits are generally higher than due diligence fees.
What’s Included in Due Diligence?
The due diligence portion of the real estate transaction takes place after an offer on a home or property is accepted but before the transaction closes. The allotted period and necessary tasks will be outlined in the Offer to Purchase contract.
Due diligence is not spot-checking one or two forms but doing the right homework to make 100% sure you won’t get hosed during closing. While all due diligence tasks differ from home to home, there are tasks you’ll see for any due diligence process including:
Title verification – You want to be sure you own the home you’re purchasing. It sounds ridiculous but titles companies report that nearly a third of all real estate transactions produce title issues according to the Washington Post. Before closing it’s critical that homebuyers verify there are no liens or other issues on the title and the person handing over the title has the legal right to do so. Most buyers and sellers protect title interests in title verification and title insurance.
Home inspection – Home inspection is another critical piece of the due diligence pie. Both buyers and sellers aren’t fans of huge cost surprises but those can be avoided with a certified home inspection.
HOAs – If the property is a member of a homeowners’ association, a potential buyer should read the HOA charter to be certain they can follow HOA guidelines.
Appraisal – You must get a third-party appraisal as part of due diligence. An appraisal could alter the contract so it must be completed before closing.
All other items necessary to complete due diligence will be outlined by your real estate agent but it’s up to you to get them done.
More Questions about Earnest Money and Due Diligence.
Is Due Diligence Refundable?
Due diligence, or specifically the due diligence fee, is negotiable but non-refundable except in the case where a seller breaches the contract. Like earnest money, the due diligence fee is put towards the down payment or otherwise awarded to the homebuyer during closing. If the buyer backs out of the contract, they will be unable to get the due diligence fee back. Due diligence fees are normally a few hundred to a couple of thousand dollars. Buyers should always negotiate for a lower due diligence fee in case they need to back out of the purchase.
What Happens When Due Diligence Expires?
The due diligence period generally lasts one to two weeks. This is considered a reasonable time for buyers to do their due diligence, but the buyer can still terminate the contract during this time without penalty. If the buyer backs out after the due diligence period expires, the seller can keep the earnest money.
Is Earnest Money Refundable?
Unlike due diligence, earnest money is refundable but only if the seller doesn’t come through. When a buyer pays out earnest money, they are demonstrating they have the money to go forward with the purchase. Should the seller not fulfill their obligations within the due diligence period the buyer can cancel the contract and receive their earnest money back. If the sale of the home does go through the earnest money is put toward the property purchase during closing.
Does Earnest Money Go Towards Down Payment?
When all necessary tasks are taken care of by both buyer and seller, earnest money will go towards the down payment. Traditionally earnest money is turned over to the title company, deposited into an escrow account until closing, then put towards the down payment during closing.
When Can Seller Keep Earnest Money?
Earnest money is meant to demonstrate that a buyer is eager to purchase a home but what happens if the buyer bails after forking over earnest money? In situations where buyers back out or don’t follow negotiated guidelines, the seller can keep the earnest money.
Moving Forward with a Great Real Estate Agent
While the above information gives you a solid overview of due diligence and earnest money, it likely can’t answer all your questions. For advice that applies to your exact situation its best to hire and communicate with a great local realtor. A great real estate team like the Storck Team knows what needs to be done with due diligence and earnest money, can explain the process for your prospective property, and make sure you aren’t taken advantage of.
Due diligence is making sure you genuinely want the house while earnest money proves you want it. Use a great real estate agent to address both and help secure the home of your dreams.
Ranked #9 in Colorado by America’s Best Real Estate Agents Real Trends for most closed transactions by an individual. Realtor®, GRI, CDPE, ABR