Earnest Money vs Due Diligence

Earnest Money and Due Diligence Money

Most homebuyers get confused by the home buying process, and understanding earnest money and due diligence are confusing. Earnest money and due diligence are two terms bound to come up when talking to your real estate agent. Whenever it is time to move, you will be a buyer or seller, and you will need to understand what they mean.

When a homebuyer makes an offer to buy a home, and the seller accepts that offer, the buyer then pays the seller a due diligence fee and earnest money, although, sometimes, the seller uses only one.

The money locks both parties into the sale while the buyer does due diligence on the home. E.g., secures their loan, gets a home inspection, etc. Of course, the seller also takes the house off the market in exchange for the money.

Both fees go towards the final purchase price (down payment) if the sale goes through.

Both benefit the buyer and seller. Here is a brief overview of why buyers and sellers like these upfront monies:

  • Buyer's Primary Benefit. The seller takes the home listing off the market to guarantee the buyer can purchase it, assuming no issues arise. Buyers do not want to waste time doing due diligence only to find out three other parties outbid them, and the seller takes one of the other offers putting the buyer back to square one.
     
  • Seller's Primary Benefit. The seller can keep the money as compensation for the time off-market if the buyer backs out in breach of contract. Sellers miss out on sales opportunities when the home is off the market; they too do not want to start from scratch or lose other offers after a due diligence period unless they have some compensation for it.

Are Both Due Diligence and Earnest Money Required?
Neither is required by law, but sellers often request both fees as a sign of good faith to show the homebuyer is serious about going through with the purchase.

The protocol is different for each state. For example, North Carolina is notorious for requiring both, while other states only require one.

In New York, buyers only pay a down payment when they sign the home purchase contract, which acts like earnest money. NY usually has no due diligence requirement.

If a state uses both, the due diligence money is often paid first, within 24 hours of making an offer. Sellers often use this time to evaluate three competing bids (in a hot market) and pick the best candidate. Things like an all-cash deal or having a loan pre-approved or a high income that HOAs prefer help push a buyer to the top of the list.

Once they pick their buyer, they refund the due diligence money to the other two losing bidders.

Then, the seller will accept the winning buyer's offer, and both will sign a purchase contract. The buyer then pays the earnest money within 24 hours of having a mutually signed purchase agreement. The due diligence time starts immediately after.

If the seller only uses one, either the due diligence or earnest money, the buyer pays the money when they have a mutually signed purchase agreement. The due diligence period starts immediately after.

So far, they sound the same, yet, they do have distinctions. So, let's now look at the key differences between earnest money and due diligence money.

Due Diligence vs. Earnest Money
The main difference between due diligence and earnest money is the amount and whether they are refundable. Earnest money is a higher amount, 1-2% of the home's purchase price and refundable, while due diligence typically is $500 - $2,000 and non-refundable.

The essence of these fees is to give the seller confidence that the buyer is serious enough to remove the home from the market while the buyer has a home inspection done.

Now, let us dive into each and learn more, then we will analyze them with a side-by-side comparison.

What is Due Diligence Money?
Due diligence money shows the seller that the buyer is serious about the property, and it provides compensation for lost time and money if the buyer backs out while the home is off the market. The seller takes the home listing off the market while the buyer inspects the house. Then, they make a final decision.

Due diligence fees are non-refundable & $500 - $2,000, paid to the seller.

The due diligence fee is non-refundable money a buyer pays directly to a seller when making an offer on a home. The buyer usually pays it to the seller within 24 hours of making the offer or signing the contract. Due diligence fees usually are negotiable, between .1% and .5% of the total price (usually around $500 - $2,000).

Sellers will credit due diligence money towards the purchase of a home at closing time.

The buyer and seller also negotiate a specific length of time called the "due diligence period," which ordinarily lasts two weeks to a month. It starts once both parties sign a contract. During this time, as we mentioned, the seller takes the house off the market and lets the buyer inspect, evaluate repairs, etc. (We will get into what happens during the due diligence process later).

What is Earnest Money?
The purpose of a buyer's earnest money deposit is to encourage the seller to consider the buyer's offer exclusively. It also protects the seller from any financial loss if the buyer chooses to back out within the due diligence timeframe.

Earnest money is refundable and 1 - 2% of the home's price, paid into escrow.

Earnest money is a small percentage, usually 1-2% of the purchase price, to prove the buyer's interest in a home. It goes into an escrow, and the escrow holder credits this amount towards the purchase of a home during closing time.

About a week after the buyer makes an offer to purchase the house and the seller accepts, they sign a purchase contract, and the buyer pays the earnest money.

This fee is larger than the due diligence fee and is typically held in an escrow account until closing or refund. However, unlike due diligence money, the earnest money is refundable within the due diligence period. (We get into what happens during due diligence later).

Both the buyer and seller must sign off on the release of the escrow before crediting the money towards the buyer's purchase.

The Difference Between Due Diligence & Earnest Money
Here are the differences between due diligence and earnest money:

Due Diligence Earnest Money
Money paid directly to the seller Money kept in an escrow account or given to another third party.
Usually between $500 to $2,000 Usually, 1-2% of the home's price
Money goes towards the home's purchase deposit Money goes towards the home's purchase deposit
Non-refundable in most cases Refundable in due diligence timeframe
Paid to compensate for the costs of removing the house from the market.

Also, it allows time for the buyer to get a home inspection and ensure the property meets inspection requirements.
Paid to compensate for the costs of removing the house from the market.

Allows time for the buyer to get a home inspection and ensure the property meets inspection requirements.

What Happens During the Earnest Money and Diligence Period?
Below is a list of what buyers and sellers do during the due diligence period:

Buyers:

Sellers:

  • Disclose all home defects
     
  • Ensure the home is accessible for evaluation
     
  • Take the home off the market
     
  • Keep the property show-ready
     
  • Answer all buyer questions
     
  • Ensure their real estate agent is still marketing the house (in case of sale cancellation)

Earnest Money FAQs

Who Pays Earnest Money?
The homebuyer pays earnest money to their attorney. The money is refunded or not depending on if both parties met the terms of the contract. It is due the day both parties sign the home purchase contract.

Is a Contract Valid Without Earnest Money?
Yes, it is still possible to work under a contract without a buyer paying the earnest money. There is no law against it. However, most sellers require earnest money, as it protects them financially.

However, if the contract requires earnest money and the buyer does not pay it, the seller can void the contract, stop the sale, and find another buyer.

Is Earnest Money Refundable?
Earnest money is refundable when the seller breaks the rules in the contract, or other issues arise. Some of these situations include:

  • The seller fails to get a home inspection
     
  • The home's inspection reveals severe problems that concern the buyer
     
  • The home's appraisal is incorrect
     
  • The buyer cannot get financing
     
  • The title examiner finds problems with ownership
     
  • When the buyer cannot sell their home by the closing date
     
  • When the buyer cannot move out of their home by the closing date

Homebuyers can get their earnest money deposit back if they cancel the contract for a reason the contract allows before the due diligence period ends. This period starts when both parties sign the contract and lasts for a few days and up to thirty days.

If either party cancels the contract, the escrow holder usually returns the money to the buyer within 48 hours.

Who Gets Earnest Money?
Buyers pay earnest money to a real estate broker, legal entity, or title company, and they deposit it into a buyer's escrow account until the sale is final. Buyers can pay with a certified check written to the sellers' attorney or wire transfer for deposit in a non-interest-bearing escrow account.

When Can the Buyer Keep Earnest Money?
The homebuyer gets to keep the earnest money (get it refunded) if the seller does not fulfill their obligations within the contract, if their loan falls through, or if they back out of the contract within the due diligence period. Examples for backing out include those listed above under reasons the earnest money is refunded.

When Can the Seller Keep Earnest Money?
The seller can keep the homebuyer's earnest money if the buyer breaches any part of the contract. Common situations include:

  • The buyer failed to meet a deadline
     
  • The buyer waived all contingencies in the contract
     
  • The buyer gets cold feet

Due Diligence Money FAQs

Who Pays Due Diligence Money?
The buyer pays the seller the due diligence money to compensate them for the time their house is unavailable to others, but it goes towards the home's purchase price if the deal closes.

Is a Contract Valid Without Due Diligence Money?
Yes, if the contract does not require due diligence money. Just like earnest money, no law requires due diligence money. However, many sellers ask for this payment as compensation for lost time and money. Therefore, if the contract requires it and the buyer does not pay it, the seller can void the contract.

How Much Are Due Diligence Fees?
Due diligence fees typically are 1-2% of the home sale price. Again, buyers pay a higher amount for a longer diligence period because you are essentially buying the time the house is off the market to secure your loan and do the inspections.

Is Due Diligence Money Refundable?
The due diligence fee is only refundable if the seller decides to back out of the deal. Due diligence money is non-refundable in all other cases.

The seller needs this protection because the buyer can walk away at any time for any reason, and that is a big hit to the seller as the home remains off the market during the due diligence period.

Who Gets Due Diligence Money?
The seller receives the due diligence money to cover the costs of taking their home off the market. But it goes towards the home's purchase price.

When Can the Buyer Keep Due Diligence Money?
The buyer can keep their due diligence money if the seller chooses not to go through with the sale. They can also keep it if the seller breaches the contract.

Examples of when the buyer can keep their due diligence money include:

  • The seller chooses not to go through with the sale after the due diligence period
     
  • The seller does not fix the requested repairs before the established deadline
     
  • The seller fails to comply or breaches the contract

When Can the Seller Keep Due Diligence Money?
The seller keeps the due diligence payment in most cases. Because, again, the fee's purpose is to compensate them for the time the house was off-market. However, the seller can lose this money if:

  • The buyer chooses to purchase the house
     
  • The buyer fails to conduct all inspections and perform necessary tasks before the deadline
     
  • The buyer terminates the contract within the due diligence period
     
  • The homebuyer backs out of the sale for contingencies not listed in the contract

Remember, though, if the deal does go ahead, the due diligence money goes towards the home's purchase price for the buyer.

Don't Forget. You Must Buy Home Insurance Before You Close!
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Hope that helps!

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