Loans insured by the Federal Housing Administration (FHA) have long played a role in many real estate transactions. In some ways, FHA loans are no different than conventional loans in that they are both made by a private lender with interest rates set by the market. In other ways, however, FHA loans have some features that are absent from conventional financing. Two key distinctions are the FHA Appraisal and the FHA Amendatory Clause. Those features may make offers contingent on obtaining an FHA loan commitment less attractive to some sellers.
Though some sellers might not want to accept an offer contingent on FHA financing, FHA loans might be the buyer’s best option or perhaps only option. In a competitive market with multiple buyers interested in the same property, a seller can possibly afford to be choosy with a buyer’s financing source. In a different market, a seller may have fewer options to make offer decisions based on a buyer’s financing source. According to the National Association of REALTORS® 2020 Profile of Home Buyers and Sellers, 16% of all buyers used an FHA loan to finance their home purchase. For first-time homebuyers, FHA financing was used in 24% of their transactions. FHA financing plays a smaller role when looking at just repeat buyers and excluding first-time buyers. Repeat buyers used FHA financing in 11% of their transactions. FHA loans can be especially attractive to first-time buyers because a buyer with a small down payment may qualify for an FHA loan but would be ineligible for a conventional loan.
Consider the following scenario: A listing agent presents three offers to a seller. Offer #1 is below list price, so the seller rejects that offer. Offers #2 and #3 are both above list price and very close in price. Offer #2 includes a Financing Commitment Contingency for conventional financing. Offer #3 also includes a Financing Commitment Contingency, but it is for FHA financing. The seller rejects Offer #3 with the FHA financing and accepts Offer #2 with conventional financing. Shortly thereafter, the buyer’s agent submits an FHA Amendatory Clause to the listing agent for the seller’s signature. The seller is confused because the buyer’s offer said the buyer was seeking conventional financing. If this sounds familiar to you, you are not alone.
Can a buyer change the buyer’s preferred source of financing after there is an accepted offer?
The language in the Financing Commitment contingencies in the various WB offers to purchase does allow a buyer to change the buyer’s financing source. Lines 270-280 of the WB-11 Residential Offer to Purchase describe the process for satisfying the Financing Commitment Contingency. Specifically lines 270-271 state, “If Buyer qualifies for loan described in this Offer or another loan acceptable to Buyer, Buyer agrees to deliver to Seller a copy of a written loan commitment.” A buyer can satisfy the financing contingency by delivering either a signed loan commitment or a loan commitment accompanied by the buyer’s written direction to deliver it. The loan commitment can be for the loan described in the offer or any other loan acceptable to the buyer. Even if a buyer’s Financing Commitment Contingency specified conventional financing, the buyer can deliver a signed FHA loan commitment, or an FHA loan commitment accompanied by the buyer’s written direction to deliver it and satisfy the Financing Commitment Contingency.
Is there a risk to the buyer if the buyer changes from conventional to FHA financing?
Changing the source of financing could be a risk to a buyer if a buyer is denied financing. Consider the situation where a buyer’s offer was contingent on financing and the buyer specified conventional financing. The buyer then applies for FHA financing and is denied. The buyer delivers the rejection of FHA financing to the seller in an attempt to demonstrate that the buyer is unable to satisfy the Financing Commitment Contingency and can then get out of the offer. The language in the WB-11 Residential Offer to Purchase at lines 284-287 Financing Commitment Unavailability specifies that, “If a financing commitment is not available on the terms stated in this offer (and Buyer has not already delivered an acceptable loan commitment for other financing to the Seller), Buyer shall promptly deliver written notice to Seller of same including copies of lender(s)’ rejection letter(s) or other evidence of unavailability.”
The seller could easily make the argument that an FHA rejection in an offer contingent on obtaining a conventional loan commitment is not evidence of financing unavailability. In this situation, the deadline for delivery of the loan commitment may pass without the buyer delivering a loan commitment, and per the Seller Termination Rights at lines 281-283 of the WB-11 Residential Offer to Purchase, the seller would be able to terminate the offer.
Why are some sellers reluctant to accept offers contingent on FHA financing?
Usually, a seller’s reluctance to accept an offer contingent on FHA financing is due to the FHA appraisal and the FHA Amendatory Clause. While not a traditional home inspection, an FHA appraisal involves elements of an inspection where the FHA appraiser will note certain condition issues that may need to be corrected or could perhaps make the property ineligible for FHA financing. The appraiser must make an inspection of the interior and exterior of the property. The appraiser has a standardized list of items and conditions to inspect. One example of a condition the appraiser must note is the condition and location of all defective paint in the home. The appraiser must inspect all interior and exterior surfaces for defective paint if the property was built before 1978. Defective paint would be paint that is chipping, flaking or peeling. If there is evidence of defective paint surfaces, the appraiser would note this and typically indicate the defective paint needs to be repaired for the lender to make the loan. Other examples of conditions that the appraiser might note may include broken windows, doors or steps; inadequate or blocked doors; or steps without a handrail. Chipping and peeling paint or replacing a handrailing are not that difficult to correct, but the appraiser might also note more serious issues such as a defective roof where the required repair means re-roofing the property.
The FHA Amendatory Clause is required in transactions where the buyer is obtaining FHA financing. In short, the FHA Amendatory Clause protects the buyer from a low appraisal. The clause states that the buyer shall not be obligated to purchase the property if the appraisal is lower than the purchase price. Additionally, if the buyer chooses not to purchase the property because the appraisal is lower than the agreed upon purchase price, the buyer is not to incur any penalty or forfeiture of earnest money. The FHA Amendatory Clause includes language stating that the buyer can proceed with the transaction if the appraisal is lower than the purchase price but is not obligated to proceed. Rather than terminating the transaction because of a low appraisal, the buyer and seller can try to negotiate through the problem by offering amendments reducing the purchase price to a number satisfactory to both parties. If the buyer and seller agree to adjust the purchase price in response to an appraised value that is less than the purchase price, a new amendatory clause is not required.
Language Required for FHA Amendatory Clause
It is expressly agreed that notwithstanding any other provisions of this contract, 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 the purchaser has been given in accordance with HUD/FHA or VA requirements a written statement by the Federal Housing Commissioner, Department of Veterans Affairs, or a Direct Endorsement lender setting forth the appraised value of the property of not less than $______________ . The purchaser shall have the privilege and option of proceeding with consummation of the contract without regard to the amount of the appraised valuation. The appraised valuation is arrived at to determine the maximum mortgage the Department of Housing and Urban Development will insure. HUD does not warrant the value nor the condition of the property. The purchaser should satisfy himself/herself that the price and condition of the property are acceptable.
Can a seller restrict a buyer’s financing source and refuse to consider offers contingent on FHA financing?
A seller may have valid reasons for not wanting to consider offers contingent on FHA financing. If there are known condition issues and the seller does not have the desire or perhaps the ability to correct condition issues, accepting an offer contingent on FHA financing is going to be a waste of everybody’s time and effort. A seller might not have the financial resources to make extensive or even minor repairs in some cases. A seller might be out of state or simply may not want to deal with repairing property conditions that will likely be a barrier to FHA financing. A listing agent who is listing a property with condition issues that will likely be a barrier to FHA financing can discuss with the seller whether the seller wants to exclude offers contingent on FHA financing.
Wis. Admin. Code § REEB 24.13(1) provides, “Refusal prohibited. Licensees shall not refuse to draft or submit any written proposal unless the terms of the written proposal would be contrary to specific instructions of the other party.” A seller decides whether to limit the presentation of certain offers. If the seller limits presentation, the listing firm may communicate the seller’s instructions to cooperating firms. Ideally, any limitations on offers should be documented in writing in the listing contract. Additionally, the seller and agent can identify this restriction as nonconfidential information in the listing contract so that the listing agent may communicate the restriction to other agents by way of MLS remarks or other avenues of communication.
In the WB-1 Residential Listing Contract — Exclusive Right to Sell, the seller and listing firm can indicate the specific terms of offers that should not be submitted to the seller. Lines 155-157 of the WB-1 provide, “Note any firms with whom the Firm shall not cooperate, any firms or agents or buyers who shall not be allowed to attend showings, and the specific terms of offers which should not be submitted to Seller:____________________________” Lines 149-150 are where this restriction would also be noted to make it non-confidential so it can be freely shared with cooperating firms.
What can a seller do to prevent a buyer from submitting an offer contingent on conventional financing and then switch to FHA financing?
If a seller wants to prevent a buyer from submitting an offer contingent on conventional financing and then switching to FHA financing, the preprinted language of the offer to purchase will need to be modified. The preprinted provisions permit a buyer to satisfy the Financing Commitment Contingency by delivering a loan commitment for the loan described in the offer or for any other loan acceptable to the buyer. If a seller receives an offer that is contingent on conventional financing, a seller could use a WB-44 Counter-Offer to delete the language “or another loan acceptable to Buyer” on line 271 from the WB-11 Residential Offer to Purchase. This limits the buyer, however, to just one option for satisfying the Financing Commitment Contingency. For example, if the buyer includes terms in the Financing Commitment Contingency but delivered a loan commitment with terms that differed from those in the contingency, the seller could argue that the Financing Commitment Contingency was not satisfied. Certainly, if a seller were willing to accept that loan commitment as satisfaction for the contingency, the parties could proceed. If the seller were looking for a way to stop the transaction from going forward, however, the seller could claim that the Financing Commitment Contingency was not satisfied and deliver a notice of termination if the deadline in that contingency passed before the buyer could deliver a loan commitment for the loan described in the offer.
Another alternative for a seller to address this issue would be to include language in the offer stating that an FHA loan commitment shall not satisfy the Financing Commitment Contingency. This information could be included in the additional provisions if the buyer were aware of this restriction. If the language was not included in a buyer’s offer, the seller could use a WB-44 Counter-Offer to add this additional language.
FHA financing plays an important role in many real estate transactions and may be especially helpful for first-time homebuyers to become homeowners. Due to down payment requirements and credit requirements that are more forgiving than conventional financing, FHA financing may allow some buyers to move beyond barriers to homeownership. There are, however, some situations where FHA financing is not suitable for the transaction, whether it is condition issues, a seller’s unwillingness or inability to make repairs, or a seller who does not want the buyer to be able to get out of the transaction under the FHA Amendatory Clause if the appraisal is low. In those transactions, it may be in everyone’s best interest to restrict offers to those that are not contingent on FHA financing or to modify the Financing Commitment Contingency such that a buyer could not use an FHA loan commitment to satisfy the contingency.
Jennifer Lindsley is Staff Attorney and Director of Training for the WRA.