By Elizabeth W. Penney, Information Officer
Earnest money is an important part of nearly all residential real estate contracts and not something that buyers like to lose. Many brokers do not understand or thoroughly explain to their buyer clients why earnest money may not be returned to a buyer if the buyer cannot obtain loan approval and thus cannot close.
Commonly, a buyer will agree on the Offer to Purchase and Contract standard form to a “due diligence period” within which to secure financing, conduct inspections of the property to be purchased, and inquire about any other matters important to the buyer. Within that period, established in the contract with the seller usually by a negotiated payment of a due diligence fee, the buyer may for any reason or no reason terminate by giving written notice of termination prior to the period’s expiration.
The “due diligence period” replaced a financing contingency in the Offer to Purchase and Contract form (developed by the North Carolina Association of REALTORS© and the North Carolina Bar Association) when it was revised in 2011. Brokers familiar with the older form may overlook or forget this change which, in effect, removed the ability to obtain financing as a contingency; instead, the buyer’s contingency became the period of time within which to inquire about the property and obtain financing. That period should be of sufficient length to enable completion of the buyer’s inquiries. If additional time is needed, it must be negotiated with the seller. Otherwise, the “due diligence period” expires without the buyer having terminated and the buyer is then unable to close, the contract provides that earnest money paid by the buyer belongs to the seller.
Under the standard form the buyer pays a fee in order to have a due diligence period. Termination before the end of the due diligence period will yield return of earnest money, but not the due diligence fee. During the due diligence period, the buyer should take the necessary steps to feel confident that their loan is going to be approved. A prequalification letter is not a loan guarantee, and buyers should be advised of the risk of moving forward after the due diligence period ends.
Ideally, buyer should consult with their lender prior to signing the offer and the buyer and broker should be confident that the due diligence period provided will allow sufficient time. The buyer’s lender should provide feedback so that the buyer is comfortable in deciding whether to terminate or proceed with the transaction. The standard form contract clearly states the loan is not a condition of the contract.
Moving forward after due diligence implies that the buyer is confident that the loan will be funded and puts the earnest money at risk if the buyer later terminates. Brokers must explain to their buyer clients about the due diligence process and the buyer’s risk if they continue past due diligence.
Offer to Purchase and Contract Standard Form
Section 1, Paragraphs h, i, j
(h) “Due Diligence”: Buyer’s opportunity during the Due Diligence Period to investigate the Property and the transaction contemplated by this Contract, including but not necessarily limited to the matters described in Paragraph 4 below, to decide whether Buyer, in Buyer’s sole discretion, will proceed with or terminate the transaction.
(i) “Due Diligence Fee”: A negotiated amount, if any, paid by Buyer to Seller with this Contract for Buyer’s right to conduct Due Diligence during the Due Diligence Period. It shall be the property of Seller upon the Effective Date and shall be a credit to Buyer at Closing. The Due Diligence Fee shall be non-refundable except in the event of a material breach of this Contract by Seller, or if this Contract is terminated under Paragraph 8(l) or Paragraph 12, or as otherwise provided in any addendum hereto. Buyer and Seller each expressly waive any right that they may have to deny the right to conduct Due Diligence or to assert any defense as to the enforceability of this Contract based on the absence or alleged insufficiency of any Due Diligence Fee, it being the intent of the parties to create a legally binding contract for the purchase and sale of the Property without regard to the existence or amount of any Due Diligence Fee.
(j) “Due Diligence Period”: The period beginning on the Effective Date and extending through 5:00 p.m. on______________________________________________________________________________________________TIME BEING OF THE ESSENCE with regard to said date.
This article came from the May 2016-Vol47-1 edition of the bulletin.