Earnest Money Deposits and Due Diligence Period – 2011 NC Changes

New 2011 NC real estate rules impact home buyer’s rights during due diligence period, due diligence deposits and refunds of earnest money deposits.

2011 has brought significant changes in real estate contracts to place an offer to purchase on a home, as well as the creation of a protective period called "due diligence period" to investigate a property before committing to a settlement date. The development of two types of deposits: the earnest money deposit and the due diligence fee creates significant rights and responsibilities for buyers and sellers while under contract and various outcomes if a party in the agreement walks away before closing.

Due Diligence Period and How It Relates to the Earnest Money Deposit from the Home Buyer

Due diligence period is a specified period of time that grants a buyer the right to complete several critical steps to investigate a property and complete lending steps after placing an offer to purchase but before closing. There is currently no standard period of time in a contract, so the length of time is variable and negotiable depending on the buyer’s needs, amount of time needed to prepare financing, and other factors. There is a comprehensive list of steps a buyer needs to complete during the due diligence period.
The contract to purchase must specify the length of time the buyer requests for the due diligence period to have the legal right to walk away from the contract and receive a refund of the earnest money deposit if the buyer at any time during the due diligence period finds a flaw or other negative factor about the property. It is essential that the buyer submits a formal communication in writing to the seller before 5 p.m. on the final day of the due diligence period in order to be eligible for an earnest money deposit refund.

It is critical for a buyer and the agent to be efficient and complete all investigations before the end of the due diligence period to maximize their understanding of the property in order to walk away with the larger earnest money deposit. This also includes the qualification process for a mortgage loan.
If the buyer can not receive lending due to a low appraisal on the home, credit issues of the buyer, or other situations that could arise during the due diligence inspections, then they may leave with their earnest money deposit before the due diligence period ends. If it is discovered after this period, the buyer will lose their earnest money deposit.
Who Receives a Refund of the Earnest Money Deposit After the Due Diligence Period Ends When a Contract Closes or is Canceled?

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    Regardless of timing, a buyer has the right to walk away from a contract at any time up to closing, even after the due diligence period ends. The downside for the buyer is that the seller will claim rights to the earnest money deposit in most cases if the buyer has not exercised their choice to cancel the deal before the last day of the due diligence period.
    One exception involves a contingent sales addendum. If a buyer includes a condition on the offer to purchase to have successfully settled on the sale of their own home before going to closing on this existing property, as long as the attached addendum is included in the original offer to purchase the buyer may be able to walk away and have the earnest money deposit refunded even after due diligence period. If this addendum is not included in the contract to purchase, the buyer may cancel the purchase but their right to a refund may not be available.
    If the buyer and seller are able to successfully go to closing, then the earnest money deposit will be credited to the seller as part of the purchase price of the property and reduce the amount of money needed at closing. If the seller fails to deliver free and clear title at closing, the buyer will be eligible for a refund of the earnest money deposit, due diligence fee (if any), and reasonable costs incurred during investigation of the property.

    What is a Due Diligence Fee and Buyer and Seller Refund Rights if Either Party Cancels a Sale?

    The separate due diligence fee paid by the potential buyer is another negotiable item in a contract to purchase. The due diligence fee is usually a smaller amount offered by the buyer to investigate the property and compensate the seller’s time to hold the property during a due diligence period. The due diligence fee is non-refundable to the buyer, and is the right to be claimed by the seller for their time. If a buyer walks away during or after a due diligence fee, the due diligence fee is not refundable to the buyer. This is important for a buyer to understand when placing a contract to purchase.
    Sellers should be aware that if a buyer walks away during the due diligence period, the due diligence fee is the only compensation they are likely to receive, as the earnest money deposit will be refunded. If the buyer walks away after the due diligence period but before closing, the seller will have the right to keep both the due diligence fee and earnest money deposit. A seller who is being requested to consider a lengthy due diligence period by a buyer may want to consider a higher due diligence fee to compensate for their time in case the buyer does not complete the process.
    The only exception where a buyer would receive the due diligence fee refund in addition to the earnest money deposit would be if the contract proceeds beyond the due diligence period and the seller fails to complete the deal buy not providing free and clear title to transfer the property rights at closing. In this situation, the buyer is not only eligible for a refund of the earnest money deposit and due diligence fee, but also reasonable expenses incurred during the property investigations as well (i.e. property survey, inspection, title search, appraisal, etc.).
    In summary, the new due diligence period is a positive change in real estate transactions with the goal of streamlining the process towards closing by reducing the chance of delays and cancellations of a sale immediately before closing. The process is meant to encourage buyers to exercise their rights to investigate a property early in the contract stages, and minimize disappointing and costly delays for buyers and sellers, as well as to clarify the claim rights to the earnest money deposits and due diligence fees in various scenarios to the buyer and seller.

    Sources:

    2011-2012 North Carolina Real Estate Manual, published by the North Carolina Real Estate Commission.Classroom Discussions, Post-licensing course for real estate agents in Contracts and Closings, CPCC, Oscar Agurs Instructor.

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