Contract Termination Right under FHA/VA Financing Addendum

QUESTION: I am the listing agent on a property that went under contract several weeks ago using the Offer to Purchase and Contract (form 2-T) (“Contract”). The FHA/VA Financing Addendum (form 2A4-T)(“Addendum”) is attached as a part of the Contract because the buyer is trying to get FHA financing. The buyer paid a Due Diligence Fee and an Earnest Money Deposit.

The Due Diligence Period is about to expire and the appraisal hasn’t been completed yet. Paragraph 4 of the Contract says that the buyer is supposed to get any appraisal done during the Due Diligence Period, but the Addendum states that the buyer isn’t obligated to complete the purchase if the property doesn’t appraise for an amount equal to the purchase price. If the appraisal comes back low after the Due Diligence Period expires, does the buyer still have the right to terminate the Contract and get the Earnest Money Deposit and the Due Diligence Fee back?

ANSWER: Yes and no. Let us explain.

As a general rule, a buyer’s failure to terminate the Contract prior to the end of the Due Diligence Period would constitute a waiver of any right to terminate the Contract and would result in a loss of the Earnest Money Deposit if the buyer was unable to complete the transaction. However, there are a few exceptions. As set forth in the “WARNING” in paragraph 4 of the Contract, “…following the Due Diligence Period, Buyer may still exercise a right to terminate if Seller fails to materially comply with any of Seller’s obligations under Paragraph8 of this Contract or for any other reason permitted under the terms of this Contract or North Carolina law.” The “Amendatory Clause” in the FHA Financing section of the Addendum is a part of the Contract as required by FHA regulations, and it survives the expiration of the Due Diligence Period. The FHA Amendatory Clause specifically provides that the buyer’s Earnest Money Deposit can’t be forfeited if the property doesn’t appraise for the purchase price; therefore, the buyer would be entitled to a refund of the Earnest Money Deposit if the appraisal comes back low.

However, we do not believe the buyer would be entitled to a refund of the Due Diligence Fee if the property doesn’t appraise. The Amendatory Clause provides that the buyer will not “incur any penalty” as a result of a low appraisal. The seller’s retention of the Due Diligence Fee should not be viewed as a “penalty” to the buyer, since the buyer received the benefit of having the right to investigate the property and the transaction during the Due Diligence Period and to terminate the Contract for any reason or no reason during that time.

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