Due diligence in real estate is the period of time between an accepted offer and closing. It is during this time that the buyer and seller agree to allow the buyer to inspect the property before closing the sale. In other words, it ensures you, the buyer, are getting what you're paying for, and that your lender is comfortable funding your purchase. Find out what happens during the due diligence period and why doing your homework can pay off in the end.
What Happens During a Due Diligence Period?
When buying a property, it pays to make sure you have all the information you need to make an informed decision. During the due diligence stage, you'll want to give every aspect of the transaction a once-over before closing the deal. In some cases, uncovering bad information may allow you to legally back out of the purchase without penalty. Review all of the following before the due diligence period ends.
Home Inspection
A home inspection is a visual analysis of a home's mechanical and physical features. It can identify potential issues with the roof; walls; doors; windows; electrical, furnace and air conditioning units; and other concerns. To ensure the property is thoroughly inspected, hire a licensed home inspector—even if your lender doesn't require you to.
If the home inspection exposes any major issues, you may be able to back out of your offer within a specified period of time without penalty if you have an inspection contingency clause written into your agreement. You might also consider negotiating any repairs with the seller before walking away. Sometimes sellers are willing to make the repairs or work out a deal rather than risk losing a sale.
Home Appraisal
A home appraisal is performed by a third-party credentialed professional who evaluates the market value of a home based on physical attributes, comparable properties in the area, the condition of the home, upgrades, amenities and more. The primary focus of an appraisal is to give lenders an idea of a home's value when underwriting a mortgage loan, and help you decide if the purchase price is fair based on the appraisal.
If the appraisal comes in lower than the price you offered to pay for the home, you have several options:
- Request another appraisal, especially if errors or basic information are missing in the report
- Renegotiate the price with the seller
- Pay more upfront to make up the difference between the sale price of the home and the loan amount approved by your lender
- Cancel the contract if you have an appraisal contingency clause in the contract
Title Search
The main purpose of a property title search is to find any hidden liens, pending lawsuits or claims on the property that the seller may not be aware of or failed to disclose. Besides establishing who really owns the property, a title search can also ensure all legal matters are disclosed and taken care of prior to the closing of escrow. Any judgments or liens not discovered before you close could mean you end up with legal expenses down the road to secure a clean title to the property.
Land Survey
A land or property survey locates and maps boundaries, features, corners and improvements on a specific piece of land or lot. In other words, it gives you a legal description of where the neighboring property begins and the property you're buying ends.
It can become a legal nightmare if, for example, you find out the detached garage that helped seal the deal on your new home is encroaching on your neighbor's yard. Depending on any issues that need to be dealt with before closing, you may have the opportunity to negotiate with the seller on the price. For example, if you think you're buying a 3-acre lot, but the land survey reveals it's actually only 2.5 acres, the discrepancy may provide the chance to adjust the sale price.
Disclosures
Sellers are generally required to disclose information about a property in a written document called a disclosure statement. The matters in the disclosure can vary based on federal, state and local laws. Some things you may find in disclosure statements include:
- A leaky roof
- Renovations completed without a permit
- Potential environmental hazards, like wildfires or floods
- Problems with the foundation, HVAC or appliances
- Whether or not there was a suspicious death in the home
The federal government requires certain disclosures no matter where you live in the U.S., like the existence of lead-based paint, asbestos or other health and safety risks. You will typically get the disclosure statement a few days before closing, although some sellers may provide this information when you first tour the home. You may also be able to ask the seller for the disclosure before making an offer on the home.
Homeowners Association (HOA) Rules
Homeowners associations, or HOAs, are typically set up to ensure homeowners maintain certain rules in a specific area or neighborhood. The guidelines are also meant to ensure the safety and protection of residents. Before you buy a home that's covered by an HOA, it's important to know what the HOA expects as well as its bylaws and covenants, such as if you can have a pet, rent out your property, decorate around the holidays or paint your house pink.
Generally, there are also fees attached to the HOA that the seller or seller's agent should inform you about prior to putting in an offer. Fees vary widely from one location to the next, but on average, HOA fees cost homeowners about $200 to $300 per month for a single-family home, according to Realtor.com.
Zoning Rules
Zoning ordinances and rules describe allowable uses for a property within a specific community. Some of these rules may weigh in on your decision to buy a home, such as if wetlands on your lot must be left undeveloped or if local flora or fauna restricts you from building an addition to your home.
Homes deemed as historic by the National Register of Historic Places also have restrictions on what you can and can't do to the home. Some limitations may include keeping the original windows and doors or preserving the exterior paint color. This may not deter you from buying a home, but learning what is expected during the due diligence period helps you be prepared going forward.
Insurance
Homeowners, by law, are not required to purchase homeowners insurance. However, most mortgage lenders require you to have insurance coverage before financing your purchase. Policy coverage and price varies significantly depending on the location, age and condition of the home.
For example, it's essential to know if the house is in a flood zone requiring flood insurance, which is not typically covered in a standard insurance policy. It is also important to know if the home is at risk for a hurricane or earthquake, the condition of the roof or if the swimming pool will require additional liability insurance so you can buy an adequate amount of coverage.
How Long Is a Due Diligence Period?
When negotiating the terms of the sales contract, buyers and sellers, along with their agents, will typically agree on the due diligence time period. This period can vary quite a bit. In some areas of the U.S., you might have anywhere from seven to 14 days to complete due diligence. In California, you have an average of 17 days.
But, some agreements can be customized if you and the seller agree to move ahead at a slower or faster pace with the purchase. Some agreements may call for much longer periods to complete due diligence depending on the complexity of the purchase. Your real estate agent or broker should be able to provide information regarding what options are available to you if problems arise during the due diligence period.
Even if you're satisfied with the inspection results, appraisal, title search and more, you will need to give written notification waiving all contingencies before the due diligence period ends. Once you do, escrow can proceed.
The Bottom Line
Due diligence is a period of time that gives you, the buyer, the opportunity to ask questions, conduct investigations and address problems so you can move forward with the purchase with confidence. And when you're ready to move ahead and close the deal, your credit score and credit report can be a determining factor with lenders. Check both for free with Experian.