FHA Loan Contingency

FHA Loan Contingency

If you are buying your home using FHA financing, there will be an FHA loan contingency included in your sales contract where the contract can be cancelled without penalty to the buyer.

Below we will discuss the FHA loan contingency scenarios for appraisal and repairs.

FHA Loan Contingency for Appraisal

According to the amendatory clause, the contract can be terminated due to a low appraisal if the buyer chooses to do so and without losing any of the earnest money.

In the event of a low appraisal, there are multiple options of how the purchase can still move forward.

  1. Increase the down payment – the buyer would need to come up with the difference between the purchase price and the appraised value as an additional down payment over and above the FHA 3.5% down payment.
  2. Renegotiate the sales price down to the appraised value – A low appraisal should be a sign to the seller that the price is too high. To get the deal to close, the seller has the option of lowering the price to meet the value on the appraisal.

If neither option works, then the buyer can walk away without penalty.

FHA Loan Contingency for Repairs

FHA guidelines require sales contracts to have a contingency for repairs. FHA inspections are extremely thorough and the loan cannot close if the home does not pass inspection.

According to the Repair Clause, if repairs are needed and the buyer and seller cannot come to an agreement, then the contract is cancelled and the earnest money is returned to the buyer.

If the home does not pass the FHA inspection, here are the options available to the buyer and seller:

  1. Seller would have to make the repairs out of pocket to meet the requirements based upon the findings in the inspection.
  2. Buyer and seller can agree to increase the sales price to cover the cost of the repairs. Then, the seller makes those repairs and the sale can move forward. The new sales price cannot be higher than the appraised value.
  3. The buyer can switch to an FHA 203k rehab loan which means the repair funds can be included in the loan and the repairs would be the buyer’s responsibility to perform within 6 months after closing. 

Read more about the FHA 203k Rehab Loan 

FHA Loan Contingency Example

This is an example of what it would look like in a sales contract when the a buyer discloses what type of financing will be used:

   (a) Loan: Buyer [ ] does [ ] does not intent to obtain a new loan in order to purchase the Property.
If Buyer is obtaining a new loan, Buyer intends to obtain a loan as follows: [ ] FHA [ ] VA
(attach FHA/VA Financing Addendum) [ ] Conventional [ ] Down Payment Assistance Program
[ ] Other:______________ loan at a [ ] Fixed Rate [ ] Adjustable Rate in the principal amount
of ____________ plus any financed VA Funding Fee or FHA MIP for a term of ___________ year(s),
at an initial interest rate not to exceed _______% per annum (the “Loan”).

Loan Contingency Removal

The FHA loan contingency can only be removed if the buyer agrees. Doing so can be risky for the buyers because they are obligated to purchase the home regardless of whether they are able to obtain a loan. They can lose the earnest money deposit if they are unable to close due to financing challenges.

Can a Buyer Switch from Conventional to FHA?

A buyer cannot switch from conventional to FHA in the contract unless the seller agrees. This is to protect the seller from a potential bait and switch situation with the buyer.

One reason why a buyer would need to switch to conventional is if something changed about their DTI, credit score, or something else that would disqualify them from a conventional approval.

Conventional Loan Contingency

For conventional loans, if the ability to get a loan and appraisal contingency have expired, then the buyers could lose the earnest money if they back out of the deal.

Can I Sell a Home Without an FHA Loan Contingency?

You cannot avoid the FHA loan contingency if you are selling a home and the buyer is using an FHA loan. The FHA loan contingency provides protections for the borrower in the event the home does not appraise or is in need of repairs that the seller will not remedy prior to closing.

It is for this reason why some sellers or their realtors do not accept offers from home buyers who are using an FHA insured loan to purchase the home. Read [Can a Seller Refuse an FHA Loan?]

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