Is The FHA Amendatory Clause Good or Bad? It's Both. What To Know
FHA loans are a powerful homebuying tool, but some aspects of FHA loans can make it harder to buy a home. Case in point: the FHA amendatory clause, which protects you as a homebuyer, but could hurt your chances of getting an accepted offer.
What Is the FHA Amendatory Clause?
The FHA amendatory clause is a protectionary measure for FHA mortgages that allows buyers to cancel their contract without penalty if the property they're purchasing does not appraise for at least the agreed-upon sales price.
This means that if a property appraises low, the homebuyer can walk away from the deal and receive a refund of their entire earnest money deposit. Without this clause, the buyer could be on the hook to pay more than the property is worth or risk losing their funds.
The FHA amendatory clause is a requirement with nearly all FHA-backed loans and must be agreed to before a purchase contract is signed.
Other Names for the FHA Amendatory Clause
In addition to the FHA amendatory clause, you may also hear lenders and real estate agents referring to the passage by a number of alternative names, including the:
FHA Escape Clause
FHA Amendment to Purchase Agreement
FHA Purchase Agreement Addendum
FHA Addendum
When the Clause is Required
As we mentioned, all buyers and sellers must agree upon and sign the FHA amendatory clause form before a sales contract is accepted.
You'll commonly see the FHA amendatory clause associated with another FHA-required form, the real estate certification, which all buyers and sellers must sign along with the selling real estate agent or broker.
This secondary document certifies that the buying and selling parties have no separate arrangement or deal outside of what is outlined in the agreed-upon sales contract.
Exceptions to the FHA Amendatory Clause
The amendatory clause is a part of nearly all FHA-backed loans. There are, however, some situations where the clause is not required:
Foreclosure sales
Homes sold by the Department of Housing and Urban Development
Homes sold by Fannie Mae or Freddie Mac
Homes sold by other federal, state, or local government agencies
When the Clause Is Enforced
The amendatory clause only applies if a home is appraised for less than the agreed-upon purchase price. In this scenario, the buyer would have the right to withdraw from the deal and receive their full earnest money deposit back.
However, that doesn't mean that they're required to abandon their purchase. It is possible to close on an FHA loan with a low appraisal. However, it would likely require the buyer to come up with a larger down payment or negotiate a lower sales price with the seller.
With any type of mortgage, lenders will issue loans for up to a fixed amount of the home's value. With the FHA, this maximum loan-to-value (LTV) ratio is 96.5%. The other 3.5% comes from the borrower in the form of their down payment.
If your home purchase appraisal is lower than the contract price, FHA lenders will still be willing to lend 96.5% of the new reduced valuation.
Example of the FHA Amendatory Clause in Action
Say, for example, that you've applied for an FHA mortgage to purchase a home priced at $275,000. You get the amendatory clause signed, and the seller accepts your offer at the full listing price.
However, the appraisal comes in at $265,000. In this situation, the FHA amendatory clause gives you the right to walk away from the deal and recoup your entire earnest money deposit. You could also negotiate with the seller to lower their price to the appraised value.
Lastly, you could simply make up the difference yourself as part of your down payment.
Since FHA lenders are willing to finance 96.5% of the property's value, you could still qualify to borrow $255,725. To go through with the deal as initially agreed upon, you would need a down payment of $19,275 compared to $9,625 based on the original price.
Remember that this increased down payment would still be in addition to any closing costs you're responsible for with your purchase.
Amendatory Clause Drawbacks
The amendatory clause is designed to protect homebuyers, but it does come with its own set of drawbacks. Most significant is that many sellers may not be willing to accept FHA loans – or will at least give them lower priority to competing offers.
Having a buyer walk away from a contract can set property owners weeks or months behind in the selling process. As such, it's typical to expect compensation for that lost time. This where the earnest money deposit comes into play. With the FHA amendatory clause, however, sellers have little recourse if the valuation comes in low.
Another issue is that FHA appraisals stick with the property for 120 days. If the seller were to accept another FHA offer during this time, they would be required to use the original appraised value. It isn't as simple as getting a second appraiser's opinion, like other types of loans.
If you're having difficulty getting an offer accepted because of an FHA loan and the amendatory clause, you may want to see if you qualify for conventional financing instead. Although borrower requirements are slightly higher, conventional mortgages have fewer restrictions – and no required amendatory clause – than FHA-backed loans.
Frequently Asked Questions
Since most other loans don't require the amendatory clause, it's common for borrowers to have some questions about the process.
Is an FHA Amendatory Clause Required?
Yes, the FHA amendatory clause form is required with just about all transactions involving an FHA-backed mortgage. The only times that you won't need to have the amendatory clause signed is when using an FHA 203(k) loan, at foreclosure sales, or when buying REO properties owned by lenders, government agencies, or Fannie Mae and Freddie Mac.
Do Other Types of Loans Have an Amendatory Clause?
The FHA amendatory clause is most commonly associated with FHA loans, but the VA does have similar requirements. If you're taking out a loan backed by the US Department of Veterans Affairs, you can expect to sign the VA escape clause, also referred to as the VA amendatory clause and real estate certification, which is similar to the requirements for the FHA program.
Keep in mind that you can add an appraisal contingency to any type of loan as long as the seller is willing to agree to it. However, only the FHA and VA require the clause to be part of the contract.
Do I Have to Cancel My Purchase if the Appraisal Is Low?
No, you are not required to cancel your purchase just because the appraisal is low. The FHA amendatory clause gives you the right, not the obligation, to walk away from the deal. Instead, you may attempt to negotiate a lower sales price with the seller or consider funding the difference yourself as part of an increased down payment.
How the Amendatory Clause Benefits Buyers
The FHA amendatory clause serves a vital role in protecting borrowers – who are often first-time homebuyers – from being locked into paying more for a property than it is worth. Thanks to the amendatory clause, FHA borrowers can walk away from a low appraisal without losing their earnest money deposit.
However, this level of protection can make it more challenging to get accepted by sellers. For more answers, or to see if you qualify for other programs, check out today's mortgage rates and apply with a reputable lender serving your community.
