When you buy a house for the first time, it's easy to feel overwhelmed with all of the new information that is coming at you from every side. And with so much happening in such a short period of time, there's no way to avoid feeling slightly nervous and skeptical about what everyone has to say. It doesn't help that real estate terms are complicated and misused quite often, which adds even more mystery and complexity to the entire transaction.
Even though a good real estate agent can help explain terminology and procedures, ultimately, it is the homeowner's responsibility to comprehend the process and make informed decisions.
Due diligence and earnest money are two examples of terms that involve both the buyer and the seller and while they might be confusing, both terms will be very important for your home buying process. Let's go over the differences between the two, what they mean for your transaction, and how you may use both to assist in securing the purchase of your home.
What Is Due Diligence Money?
Due diligence money is defined as a fee paid by the buyers when they submit an offer on a home.
When a contract is signed, the "due diligence" period officially begins. This is a predetermined period through which a buyer may conduct any important inspections or research to feel confident in proceeding. The due diligence period normally lasts fourteen to thirty days, giving you enough time to consider termite inspections, home inspection, appraisals and more.
In this stage, the seller removes the home’s listing while the potential buyer conducts inspections. As someone who is looking to purchase the home, you have that time to evaluate inspection reports, HOA bylaws guidelines, negotiate repairs, and take any other steps you deem necessary before making a final decision on the purchase and submitting an offer.The main goal for paying a due diligence fee is to reimburse the seller for the time they spent removing the home off the market. During the time the seller removes the home, if the prospective purchaser decides not to buy it, the seller may have lost out on another buyer throughout the period.
What Tasks Can Be Completed During The Due Diligence Time?
While due diligence tasks vary by home, common things to investigate are:
According to the Washington Post, title companies claim that over a third of all real estate transactions result in title difficulties. Before closing, homebuyers must ensure that the title is free of liens and other difficulties and that the person giving over the title has the legal authority to do so. In title verification and title insurance, the majority of purchasers and sellers safeguard their title interests.
Another important aspect of due diligence is the home inspection. Both buyers and sellers dislike large-cost surprises, but they can be prevented with a certified home inspection.
If the property is part of a homeowners' association, a prospective buyer should read the HOA charter to ensure that they can obey the rules.
As part of your due diligence, you must obtain a third-party appraisal. An appraisal may change the contract, requiring it to be performed before closing.
The Due Diligence Fee And Role
The due diligence fee is distinct from the earnest money deposit. When you make an offer that the seller accepts, the seller will be paid out. Consider this as a non-refundable deposit that will allow you to proceed with assessments and inspections.
Due diligence allows you to acquire a better idea of what you're getting yourself into with property over a longer period of time. However, if you only have a few weeks, you must conduct due diligence as a prepared buyer.
What Is The Process For Due Diligence?
When the seller accepts your offer, you will sign a contract. Make sure to thoroughly read the contract to see how much time is allotted for the process.
Keep in mind that you will need to figure out the house financing during the early stages of due diligence, even before you make an offer. This includes getting a loan authorized and determining how much of a down payment you can afford. In addition, your lender will want to see proof of your ability to make periodic mortgage payments, such as savings and cash flow.
During the process, get the house inspected. At this time, the HVAC system, foundation, roof, and electrical systems will all be examined by a house inspector. You will also need to have the house appraised and a property survey completed.
What Is Earnest Money?
Let’s switch gears and talk about earnest money. Similar to due diligence money, earnest money is a loyalty payment that shows the seller that a particular buyer is interested in buying the house. Earnest money is a portion of the contract value that is negotiated and usually amounts to around one percent.
The earnest money remains in escrow by a mutually agreed-upon agency until the transaction is completed, unlike due diligence which is charged right away. If the seller is unable to follow through with the contract, the money is given back.
If the agreement is canceled well within the due diligence period, the earnest money is refunded.
How Much Earnest Money Should You Put Down?
Depending on where you live, the answer to this question differs. You may be required to put down a modest percentage of the home's worth in some cases. This amount may be as low as three percent.
If you are purchasing a $300,000 home, you will need to put down roughly $9,000 in earnest money— the greater the house's price, the more earnest money you must pay. Make sure to account for this money when saving up to purchase a home.
The earnest money sum may be regulated in other countries. To know what to expect, review your state's requirements and ask your real estate agent.
Understand The Role Of Earnest Money In The Transaction
Where does the earnest money go? Is it possible for you to add a higher amount? It is important to know the answers to these questions if you want to win a bidding war with the seller. Let’s look at these questions to help you understand more about earnest money.
1. What Happens To The Money?
Your earnest money must be placed in an escrow account. Consider an escrow account to be a safe haven for your funds.
It is critical to entrust the money to a third party, such as a bank. Do not give money directly to the seller with the expectation of receiving it back. Additionally, keep the funds safe and ensure everything is documented.
2. In A Competitive Housing Market, What Should You Do?
What if you're attempting to purchase a home in a seller's market? You may put down more earnest money if there is a lot of competition for a home. This is a strategy that could benefit you and convince the sellers that you mean business.
Putting down a larger deposit demonstrates that you have the financial means to pay for the home and it also shows your interest. It demonstrates that you are a serious buyer and the seller may be further inclined to accept your offer.
Earnest Money vs Due Diligence
Due diligence should be conducted using a budgeted method. Understanding when you will be accountable for these payments is the first step. In other words, during due diligence, you must immediately come up with the needed cash. Keep in mind that this money isn't always refundable if you decide not to proceed with the transaction.
Earnest money on the other hand is used when you are sure about buying a property and is generally used to bind an offer and show good faith on the part of the buyer.
In both cases, make sure you have the cash on hand — and maybe a little more “pocket change” if the house is in high demand.
Is Due Diligence And Earnest Money Refundable?
Except in the instance of a seller breaching the contract for any reason, due diligence, or specifically the due diligence charge, is negotiable but non-refundable. The due diligence charge, like earnest money, is applied to the down payment or otherwise given to the buyer at closing. The due diligence cost will not be refunded if the buyer was to terminate the contract.
Since due diligence fees often range from a few hundred to a few thousand dollars, if a buyer needs to back out of a deal, they should always try to negotiate a reduced due diligence fee.
Earnest money, unlike due diligence, is refundable only if the seller fails to deliver. When a buyer pays earnest money, they indicate that they have the funds to complete the transaction. If the seller fails to meet their responsibilities during the due diligence period, the buyer has the option to cancel the contract and demand a refund of their earnest money. If the home sale goes through, the earnest money is applied towards the purchase of the property at the time of closing.
At closing, both due diligence money and earnest money are applied to the purchase value.
To summarize, the following are the most important points to remember concerning due diligence money and earnest money:
Due Diligence Is:
Earnest Money Is:
While there are similarities between the two types of payments such as both payments being credited to the home price, there are also a lot of differences. While purchasing a home, you need to know the definition of both the terms.
Due diligence fees and earnest money are permissible and popular in real estate transactions, but they may not apply when you are shopping for any home outside of America. Talk to your realtor if you are unsure about what to demand during your transaction.While it may initially be stressful to step your foot inside the real estate market, and to learn about terms such as due diligence and earnest money - the perks of owning your home are endless.
The Benefits Of Owning Your Own Home
The most important part of owning a home is that it can be yours. Being a homeowner means having a piece of something that is always growing in value. When you purchase a new home or investment property, you become an owner of real estate.
According to home pricing studies, homes have historically shown that they increase in value over time at rates much higher than inflation.
Owning a home also has some great tax advantages and can help you keep more money in your pocket throughout the year. Also,
Finally, owning your own home gives you complete control over the way it looks on the inside and outside. Happy house hunting!