What is Due Diligence?
"What is due diligence?" It's a question I get a lot - especially from first-time home buyers. A lot. It's a phrase you often hear when researching buying or selling a home...or watching HGTV. Understanding the phrase can go a long way to demystifying the home-buying process. So what does "due diligence" mean?
Due Diligence refers to two different, but related things: the Due Diligence Fee and the Due Diligence Period. To avoid having to type that phrase (and you having to read it) fifteen-hundred times, I'll shorten them to the "Fee" and the "Period."
But what are they, and how do they impact the home buying process? Read on, it's not as complicated as it seems.
First off, the phrase itself - due diligence - generally means the steps you take to investigate and research something before entering into a contract regarding that something. Simply put, "do your homework."
So the Due Diligence Period gives us time to "do our homework" regarding a house, and the Fee is buying us that time. Now to dive into each with a little more detail.
Due Diligence Fee
The due diligence fee is money given directly to the seller in exchange for them taking their house off the market for a given time. (It's what makes a house go from "Active" to "Contingent" on your favorite property search site) This allows the buyer to schedule inspectors, specialists, and any other professionals to ensure all the systems and features of the home are functioning properly.
The amount of the Fee is completely negotiable. Budgeting around 1% is a good starting point, but remember, every offer is different. There are plenty of other variables that factor in.
The money - usually a personal check - is written directly to the seller. The seller is able to deposit the Due Diligence Fee immediately. So if the buyer decides to walk away, that money is typically gone. On the bright side, it will appear as a credit for the buyer on the closing statement. Meaning, that amount will apply towards any of the buyer's closing costs.
Lastly, the Due Diligence Fee is due when the offer is accepted and fully signed by all parties. I tell my clients to have their checkbooks ready when we make an offer. That helps avoid any delays in starting the process.
Due Diligence Period
So what's the Due Diligence Period? Glad you asked. The is the time frame in which the buyer has to inspect the home.
As with the Fee, the time frame is negotiable. I've heard of Periods as little as 7 days, and as long as 2 months. Most land somewhere between 21 and 30 days. This gives the buyer time to schedule an inspector, and then any specialists (like HVAC technicians or plumbers) to determine if anything needs to be repaired or replaced.
Negotiating those repairs is a whole article in itself, so we'll skip it for now.
During the Due Diligence Period, the seller must allow "reasonable access to the property" during this time. That's a must...it's actually written into the contract.
If the buyer wants any repairs or concessions, the buyer and seller must agree on them before the Due Diligence Period is over. Once it ends, there are a few things to wrap up, and then it's time for closing day.
A Few Exceptions
Above, I wrote that the Due Diligence Fee is "typically gone." There are a few rare exceptions to that, but they're important to understand.
The first is a problem in the survey. This is one reason why I always recommend getting a survey. The second is any defect in title. More simply put, if the seller can't legally sell the house, a buyer is entitled to get their Due Diligence Fee back. Yes, it happens, but it's also rare.
Bringing it all together
Now you have a more clear understanding of what the Due Diligence Fee and Period are. They're an important part of protecting the buyer while also compensating the seller for their time. The Due Diligence Fee, in particular, can be a major factor in a successful offer. I recommend becoming comfortable using these terms during your house hunt - savvy negotiators know they can give you an edge.
I'm also a fan of bullet points. So now that you're an expert like me, here are the cliff notes in case you want to jog your memory.
The Due Diligence Fee
Money written directly to the seller
"Comes back" as a credit to the buyer
Triggers the start of the Due Diligence Period
The Due Diligence Period
Typically between 21 and 30 days
Allows the buyer to inspect the home
Must be agree on repairs and concessions before it's over