Appraisal Contingency

An appraisal contingency is a provision in a real estate purchase agreement that releases the buyer from the obligation to complete the purchase, or opens a renegotiation, if the property is valued below the contract price. On an ordinary conventional purchase the clause is negotiated rather than prescribed, and it is common for the same protection to be built into the financing condition instead, because a shortfall in value fails a loan condition rather than a condition about the property itself. Whether a termination under it returns the buyer's earnest money is decided by the purchase agreement, which is that term's own subject rather than this one's.

Two federal loan programs are the exception. Both write the clause for the parties, and neither uses the market's name for it. VA calls the provision an amendment to the contract; the mortgage industry calls the VA version the escape clause. FHA calls its own the amendatory clause. Recognizing that all three names describe the same protection is most of what a buyer needs from this term.

The VA version is in the Code of Federal Regulations, and it is narrower than it is usually described. Under 38 CFR 36.4303(k), no guaranty or insurance commitment will be issued on a loan financing a contract that (1) is for the purchase, construction, repair, alteration or improvement of a dwelling or farm residence, (2) is dated on or after June 4, 1969, (3) "[p]rovides for a purchase price or cost to the veteran in excess of the reasonable value established by the Secretary", and (4) "[w]as signed by the veteran prior to the veteran's receipt of notice of such reasonable value", unless the contract includes or is amended to include a provision reading substantially as follows:

"It is expressly agreed that, notwithstanding any other provisions of this contract, the purchaser shall not incur any penalty by forfeiture of earnest money or otherwise be obligated to complete the purchase of the property described herein, if the contract purchase price or cost exceeds the reasonable value of the property established by the Department of Veterans Affairs. The purchaser shall, however, have the privilege and option of proceeding with the consummation of this contract without regard to the amount of the reasonable value established by the Department of Veterans Affairs."

All four numbered conditions have to hold. The one people miss is the fourth: the requirement is aimed at a veteran who committed before knowing what VA thought the property was worth. "VA requires an escape clause in every contract" states the rule more broadly than the regulation does. Note also what the clause hands the buyer, which is an option in one direction only. It removes the obligation to complete and it removes the forfeiture, and it expressly preserves the privilege of going ahead anyway.

The FHA version has a regulatory root and a handbook text. The root is 24 CFR 203.15, which requires an insurance application to be accompanied by an agreement under which the seller or builder "will deliver to the purchaser of the property a written statement, in a form satisfactory to the Commissioner, setting forth the amount of the appraised value of the property as determined by the Commissioner." HUD implements that through the amendatory clause described in its Single Family Housing Policy Handbook 4000.1 at II.A.1.b.(i). In the handbook version last revised on 14 August 2019, the clause applies where the borrower did not receive form HUD-92800.5B, the Conditional Commitment Direct Endorsement Statement of Appraised Value, before signing the sales contract, and provides that the purchaser "shall not be obligated to complete the purchase of the property described herein or to incur any penalty by forfeiture of earnest money deposits or otherwise" unless given a written statement of an appraised value of not less than a stated amount, while keeping "the privilege and option of proceeding with consummation of the contract without regard to the amount of the appraised valuation." The same section lists sales that do not need it, including HUD real-estate-owned sales, the 203(k) program, sales where the seller is Fannie Mae, Freddie Mac, VA, USDA Rural Housing Services, another government agency, a mortgagee disposing of real-estate-owned assets or a seller at a foreclosure sale, and sales where the borrower will not be an owner-occupant. HUD revises the handbook section by section, and the footer of the consolidated PDF says so itself, directing the reader to "the online version of SF Handbook 4000.1 for specific sections' effective dates". So treat the wording above as the edition it came from, and check the current handbook before relying on it.

The blank in the FHA clause is not a threshold. HUD's own footnote to the clause directs mortgagees to insert the actual dollar amount of the sales price stated in the contract, and says that an increase in the sale price requires a revised amendatory clause. The number in the blank is therefore the price the parties agreed, not some minimum valuation the buyer negotiated.

On a conventional purchase the boundary with the financing condition matters more than the label. A lender's maximum loan is calculated against the lesser of price or value, so a low valuation shows up first as a loan that is smaller than the buyer planned. A buyer who waives a standalone appraisal condition but keeps a financing condition may still have an exit, and a buyer who waives both while promising to make up any shortfall in cash has none. Which clauses are in the contract, and how they interact, is a question to settle before the offer goes in rather than after the valuation lands.

On a conventional purchase the clause names a deadline, an event, and a remedy: the buyer obtains a valuation, and if it lands below the contract price within the stated period the buyer may terminate, or may give notice and negotiate. On an FHA or VA purchase the applicable federal clause operates automatically once its conditions are met, without the buyer having to negotiate for it. Under either federal version the buyer may also proceed at the agreed price. Whether the deposit is returned on a termination is answered by the purchase agreement, which is earnest money's subject.

A hypothetical using the FHA clause. Marisol signs a contract at $352,000 before she has been given the statement of appraised value, so the amendatory clause is added with $352,000 written into the blank, that being the sales price. The valuation comes back at $338,000. Under the clause she is not obligated to complete the purchase and does not forfeit her deposit, and she may still buy at $352,000 if she chooses. The gap she would have to cover if she went ahead is $352,000 − $338,000 = $14,000, because the mortgage is calculated against the lower of price and value.

If the parties instead renegotiate to $344,000, HUD's footnote is worth knowing in reverse: an increase in the sale price requires a revised amendatory clause, so a later upward renegotiation is not a paperwork-free change. Figures are invented for the illustration.

Pros

• It is the difference between renegotiating a price and finding a shortfall in cash on a deadline.
• The federal versions are prescribed rather than negotiated, so an FHA or VA buyer gets the protection without having to ask for it or pay for it.
• Both federal versions preserve the buyer's option to go ahead anyway, so the clause never forces a buyer out of a purchase they still want.
• It puts a professional valuation between the buyer and a price set in a competitive moment.

Cons

• On a conventional purchase nothing prescribes the wording, so two contracts using the same name can give the buyer very different exits.
• The VA clause is conditional on all four of its tests, including one about when the veteran signed, so a buyer who assumes it always applies may be wrong.
• FHA's clause has a list of exempt sales, and a buyer purchasing from one of the named sellers does not get it.
• It is among the first conditions buyers are pushed to waive when offers compete, and waiving it converts a valuation risk into a cash obligation.
• It does nothing about condition. A property can appraise at the contract price and still need a new roof.