What Is An FHA Amendatory Clause?

When you're on the hunt for a mortgage, you may eyeball a Federal Housing Administration (FHA) loan to purchase a home, especially if you a lower credit score and smaller down payment. The FHA is under the U.S. Department of Housing and Urban Development (HUD) and provides mortgage insurance on loans made by FHA-approved lenders.

FHA loans are a popular choice among home buyers, and it's a good idea to understand how different parts of the loan work. That includes the FHA amendatory clause, also called an "escape clause."

The FHA Amendatory Clause, Explained

For the purchase of a home to "go through," a borrower must sign an amendatory clause. The FHA amendatory clause is a disclosure that goes into effect for those who choose to purchase a home using an FHA loan. If the home appraisal comes in below the agreed-upon price of a home you plan to purchase, the FHA amendatory clause enables FHA home buyers to cancel the home purchase and receive a refund of their earnest money. In short, it will allow you, the home buyer, to back out of the sale without any sort of penalty.

When The Clause Takes Effect

The amendatory clause takes effect when an appraisal comes in at less than the selling price. Let's say your offer matches the for-sale price of $250,000. If the appraised value comes in at less than $250,000, you would have to pay the difference because you cannot get a loan for more than the appraised value. You don’t have the money to pay the difference out of pocket and the seller won’t budge on the sale price. This is when the amendatory clause kicks in and allows you to back out of the sale.

Note that if you still want to go through with the home purchase, you can agree in writing to accept a lower price or negotiate to pay all or a portion of the difference.

Why The Clause Is Good For Buyers

Appraisals ensure that lenders do not approve a loan for more money than the property is worth. Appraisals also protect buyers from overpaying for a property. The clause protects home buyers because they can walk away from a home purchase and also get their earnest money deposit back.

Who Signs And When

The buyer, co-buyer, seller, buyer's agent and seller's agent must sign the FHA amendatory clause. The FHA will not insure or guarantee the loan if it’s not signed.   

When The Clause Is Required

An FHA amendatory clause is not required on certain home purchases, including in the following situations:

• HUD real estate-owned sales
• Home sales by government agencies like Fannie Mae, Freddie Mac, the Department of Veterans Affairs (VA), Rural Housing Services
• Foreclosure sales
• Sales where the borrower will not become the owner-occupant

Real Estate Certification Form, Explained

The FHA Amendatory Clause and Real Estate Certification often go hand in hand. The real estate certification form states that those signing the sales contract acknowledge the terms and conditions of the sale as laid out in the sales agreement. The individuals signing must certify to the best of their knowledge that the terms and conditions of the sales contract are true and any other agreement connected to the real estate transaction is part of the sales agreement.

The real estate certification states that the seller, buyer, real estate agent and everyone else signing the sales contract acknowledge the terms and conditions as stated in the sales agreement and that there are no "side agreements" involved, which are not spelled out in the sales contract.

The Bottom Line

The FHA amendatory clause protects borrowers because if the appraisal comes back low, the buyer can cancel the transaction and get their earnest money back. Signing on the dotted line for a home that appraises for below the sales price could result in a bad investment for both lenders and buyers.

Therefore, FHA addendums like this add provisions and protections to a purchase agreement to protect both the buyer and lender and protect a buyer's deposit.

Are you ready to purchase your own home? Whether you're exploring an FHA loan or another type of loan, start the mortgage approval process today.