There are a lot of terms and expenses to keep track of when you’re buying a home. You’ve got your down payment and closing costs, but you may also need an earnest money deposit. Depending where you live, you may also opt to put down a due diligence fee with your offer.
Due diligence vs. earnest money deposits can be confusing, because both are paid when your offer is accepted and they serve similar purposes. But there are differences, and it’s worth knowing how much you might need to put down once you go under contract on a home — not to mention what to expect during your due diligence period.
What's in this Article?
Due diligence is your and your lender’s opportunity to do your “due diligence” to make sure the home is in good condition and that you can afford the loan. You can back out of the sale at any time before the end of the due diligence period.
This period begins after the seller accepts your offer on the house and you both sign the sale contract. At that point, you’re “under contract,” and your due diligence period begins.
From the buyer’s perspective, the due diligence process includes getting an inspection and appraisal to verify that the home is satisfactory and that the sale price matches the value, said Elizabeth Leanza, REALTOR at Realty One Group Music City in Franklin, Tenn. This process helps the buyer ensure the home’s livability and safety and to decide whether it’s the right place for them.
The due diligence period is also when your lender will request a title search. Your lender might also order a property survey and request more financial documents from you during this time.
Due diligence fees
The due diligence period is crucial to the homebuying process, because you want to learn everything you can about the home before you go through with the purchase.
From the seller’s perspective, though, the due diligence period can seem risky. Once they accept your offer, they’re legally barred from showing the home to anyone else. If you get to the end of a 30-day due diligence period and decide you don’t want to buy it after all, the house goes back on the market.
But the longer a house is on a market, the less desirable it seems. So they’ve now lost a month in which they might have shown the property to other homebuyers, and the added time on the market could cause them to get less than they want in the sale.
That’s where a due diligence fee may come into play, particularly if you live in North Carolina.
The due diligence fee, which is common in that state and possibly others, essentially makes it worth the seller’s while to accept your offer and risk taking the home off the market during your due diligence period. This fee is not required; it’s an optional deposit you can make to sweeten your offer.
If you buy the house, the fee gets credited to your cash needed to close. But if you don’t buy the house, the seller gets to keep the fee as compensation for the time and opportunity lost. Due diligence fees are non-refundable if you cancel the sale contract. The seller refunds the money only if they’re the ones who back out of the sale.
Are due diligence fees mandatory?
Due diligence fees aren’t mandatory, and they may not be necessary or allowed in every market, as real estate laws and norms can vary significantly throughout the country. But if you’re looking for a house in a city or neighborhood where demand is sky high, offering a due diligence fee can help persuade a seller to accept your offer over the others they may be receiving.
A due diligence fee can also assuage a seller’s fears if you want a longer-than-average due diligence period. Maybe you’re worried about being able to get inspectors over to the house in a timely manner, or you want to consult with contractors about anticipated renovations before you make a final decision. Those are valid concerns, and you should learn everything you can about a home, and get all of your questions answered, before you close.
But again, if the answers to your questions cause you to back out of the sale, the seller has lost time and possibly money. So a shorter due diligence period is in their interest. If you want more time, a due diligence fee can help buy that for you.
Because the fee is non-refundable, however, think carefully before you include it in your offer. And be sure to ask your real estate agent if due diligence fees are common where you’re buying. You don’t want to put money at risk if it’s not necessary to compete.
If you are buying in a place where due diligence fees are common and properties are in demand — an area such as North Carolina’s Research Triangle, for instance — only offer an amount you are prepared to lose. If you commit $5,000 in due diligence money because you think you’ve found your dream home, only to discover it’s riddled with problems, you will lose that $5,000 if you cancel the sale.
In addition to your due diligence fee, if applicable, you will need cash available for home inspections.
Your lender will schedule an appraisal, and you’ll pay the appraisal fee as part of your closing costs. But home inspections are optional (though you should not skip them), so you pay that out of pocket directly to the home inspection company.
If you have contractors come to the house to give estimates on renovations or repairs you hope to have done on the home, you’ll need to pay any fees they charge directly as well. Note that you cannot order any repairs until you own the home, and some contractors offer free estimates. But if they charge for estimates, you’re responsible for those costs.
This is your opportunity to make sure the home can accommodate your needs, so try to think about additions or upgrades you may want to make long-term.
“For example, I want to make sure I can put in whatever type of fencing I want, and typically don’t want to make a contract contingent upon that because the more contingencies you have, the less desirable your contract is to a seller,” Leanza said. “So we usually squeeze all those things in during the [due diligence period] so if something comes up that’s unfavorable that may be outside of the inspection, we have a chance to terminate.”
Any money paid out to inspectors, appraisers, surveyors, and contractors is almost always non-refundable.
Earnest money, which you can think of as trust money or good faith money, “tells the seller, ‘I, in good faith as a buyer, am choosing to operate in good faith. I’m not going to be in breach of contract. I want to go through the motions properly. And if I am in breach of contract, you get to keep this money,’” said Michael Kelczewski, a real estate professional at Sotheby’s International Realty. “The higher that earnest money, the better, the more appealing it is to the seller because if the buyer does breach, they keep it.”
Earnest money gets credited to your down payment and closing costs. Unlike the due diligence fee, earnest money is refundable if you decide to back out of the sale, unless the contract specifically states otherwise due to negotiations.
The earnest money deposit can range from $500 to 1% of the home’s sale price, according to Michael Bendebba, a branch manager with Fairway Independent Mortgage Corporation (Fairway owns Home.com).
But it serves a similar purpose to the due diligence fee, and it’s a highly common part of real estate transactions.
“Earnest money isn’t necessarily required for a contract, although it’s very customary and most sellers would not entertain a contract where their prospective buyer lacked any skin in the game,” Kelczewski said. “Is it needed or not? Technically, no, but in practice, yes. I’ve sold hundreds and hundreds of properties, and I’ve never had a sale without any earnest money placed in an escrow account for the contract.”
Unlike your down payment and closing costs, which you pay at or right before your closing, due diligence and earnest money deposits are due once a seller accepts your offer.
That’s why you shouldn’t offer more earnest or due diligence money than you have on-hand in liquid accounts.
The earnest money is held in an escrow account until closing, and the due diligence fee (if you’re paying one) is paid directly to the seller.
The good news is, these deposits count toward your down payment and closing costs; they’re not extra fees on top of those big lump sums.
When you submit your earnest money deposit check, it gets held with an escrow agent, such as the closing attorney, title company, or whoever is overseeing the closing.
The escrow company is a third party that does not specifically represent the buyer or seller. Your money is safe when deposited with escrow.
“This is really important because there are misconceptions. People think, ‘It’s being held, oh, it’s not going to be deposited,’ when it is deposited,” Leanza said.
Know that earnest money is highly regulated by states, said Kelczewski, and is typically required to be in noninterest or interest-bearing escrow accounts. Both due diligence and earnest money deposits cannot be mingled with other funds, such as your real estate agent’s commission, and the money is protected in an account dedicated to your transaction, he added.
However, depending on negotiations, the seller may be the party to receive the earnest money upfront when the contract is executed. In that case, your lender may request evidence of your earnest money check withdrawing from your bank account when the seller deposits it. This is to document your earnest money transaction so you can receive credit toward your closing costs and pre-paids at closing.
Yes. If you decide not to buy the house, you can get your earnest money deposit back as long as you cancel the contract within your due diligence window. If your due diligence period ends and you decide the night before closing that you don’t want to move forward, the seller may be entitled to your money.
“If you simply change your mind and decide not to buy the home, you might lose your earnest money deposit,” Bendebba said. “However, if you do your due diligence and do everything that you agreed to under the terms of the sales contract, but due to circumstances beyond your control cannot move forward, you will not lose your earnest money deposit.”
Additionally, you will likely not get your earnest money deposit back if you don’t close on time. That’s why it’s essential to submit all of your documents to your lender as soon as possible so there are no delays in processing your loan.
It’s also why you want to ask your lender about their average closing time and how often they close on time. A missed closing could cause a seller to back out of the sale altogether, taking your earnest money deposit with you.
Related Reading: Ask a Lender: What’s Your Average Mortgage Closing Time?
Because due diligence fees and earnest money are “completely discretionary,” says Kelczewski, you can put down as much as you’d like to stay competitive while protecting your interests. He advises clients to put down the lowest amount of earnest money and due diligence deposits as possible while taking into account the highest and best offers the sellers are receiving.
Even though earnest money and due diligence deposits aren’t required by law, a good rule of thumb in today’s competitive market is the more financial skin you have in the game, the better.
“The higher that earnest amount, the more appealing for that seller because what that means is, ‘If I default, I’m willing to give you this much,” Leanza explained. “You want to put down about one to one and a half percent of the purchase price.”
Of course, you want to avoid losing that money at all costs.
Here are some ways to protect your deposit
- Ask your real estate agent how long a due diligence period they recommend based on conditions in your local market and the types of inspections you hope to have done. You want the due diligence period to be long enough that you can get the answers you need about the property.
- Find out your exact due diligence time period and be sure all of your inspections are scheduled well before the last day. Give yourself at least a few days to digest all of the information that comes back so you can make a confident final decision about whether to buy the house.
- Have your real estate agent explain all contingencies and the process for backing out of the sale just in case. You should understand the timeline and exactly when you need to make certain decisions so you don’t miss your chance to get your earnest money back.
- Respond to your loan officer immediately if they ask for additional bank statements, tax returns, or other key documents. Your lender needs certain documentation to process your loan, and if you take too long getting it to them, you could jeopardize your closing date.
The homebuying process can be intense, especially after you go under contract. But it’s important to stay focused and make it a top priority to avoid losing out on the home or on a large sum of money.
“It’s a deposit. You get it back, if you terminate on agreed upon contingencies,” Leanza said. “You don’t get it back if you get cold feet and try to cancel the day before closing.”
The best thing you can do to avoid losing your earnest money deposit is to be clear on the terms at the outset.
“Make sure you and your agent review this and understand what is expected of you under the terms of the sales contract,” Bendebba said.
Due Diligence vs. Earnest Money FAQs
Due diligence is not refundable if you back out of the purchase due to a contingency like the home inspection or appraisal. Earnest money is refundable if a ‘deal killer’ appears and you wrote that contingency into the contract.
The due diligence period begins when a seller accepts your offer on a home, known as going under contract. During that time, your lender will schedule an appraisal and process your loan application, and you can schedule inspections.
Although it’s not required, many buyers include an earnest money deposit with their offers, which serves as a “good faith” deposit to show the seller that you’re committed to the purchase. The earnest money deposit is credited toward your down payment and closing costs if you buy the home. If you opt out of the sale during the due diligence period, the earnest money deposit is refundable.
In North Carolina, it’s also common for buyers to offer a due diligence fee, which effectively compensates the seller for the risk of accepting your offer and taking the home off the market during your due diligence period. If you buy the home, the due diligence fee is applied to your down payment and closing costs, just as the earnest money deposit is. But if you choose not to buy the home, the seller keeps the due diligence fee.
Yes, as long as you do so before the due diligence period ends and in accordance with the terms of the contract. If you violate the terms, the seller may be allowed to keep the earnest money, so make sure you understand what you’re committing to before you sign the sale contract.
You can choose not to buy a home at any time until you close and sign the loan documents. However, if you do not cancel the sale contract until after your due diligence period ends, the seller may be entitled to keep your earnest money deposit. If you put down a due diligence fee, the seller keeps that amount when you back out of the sale. Due diligence fees are only refundable when the seller cancels the contract.
Should you pay a due diligence fee?
When you’re a homebuyer considering due diligence vs. earnest money it’s best to keep in mind that both may be necessary to complete your home purchase.
One is a positive, in-good-faith-money-in-the-game deposit (earnest money) and the other is to provide you with the time to complete necessary tasks to ensure the home passes your needs and current regulations (due diligence). If there’s anything in your contract pertaining to these two deposits that’s unclear, make sure to seek advice from your attorney and real estate agent.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.