Low FHA Appraisal, Seller Credit, and Cash Gap
Buyer has an FHA preapproval for a $300,000 purchase price, 3.5% down, and a 30-year fixed loan at 6.25%. The seller agrees in the contract to pay $9,000 toward the buyer's closing costs and prepaid items. The FHA appraisal comes back at $285,000. The lender says the maximum FHA base loan is 96.5% of the appraised value, or $275,025, and that the buyer must cover the difference between the price and the appraised value. The buyer has $12,000 in verified funds and is counting on the seller credit to cover closing costs, which are estimated at $8,500. The buyer's agent notices the contract has no separate appraisal contingency, but the FHA amendatory clause is included. The seller refuses to lower the price, saying the buyer agreed to $300,000. The buyer wants to know whether to terminate, renegotiate, or bring more cash, and whether the $9,000 seller credit can be used to fill the appraisal gap.
1. Calculate the buyer's cash gap if the price stays at $300,000, and explain how the seller credit can and cannot be used.
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The maximum FHA loan is 96.5% of $285,000, or $275,025. The buyer must pay the $300,000 price minus $275,025, or $24,975, in cash or other allowable funds, plus closing costs. FHA seller concessions may pay certain closing costs and prepaids, up to the applicable cap; here $9,000 is 3% of the sales price, within the 6% cap. The credit cannot be used to cover the buyer's down payment or the appraisal gap because it is a seller concession, not the buyer's own funds. If closing costs are $8,500, the $9,000 credit can cover those, but the buyer still needs roughly $24,975 for the price gap. With $12,000, the buyer is short about $12,975 before any lender reserves or prepaids not covered.
2. If the buyer terminates under the FHA amendatory clause, what happens to the earnest money and due diligence fee?
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The FHA amendatory clause provides that the buyer is not obligated to complete the purchase and may cancel if the property does not appraise at or above the sales price. If the buyer cancels under that clause, the buyer should recover the earnest money because cancellation is permitted by the contract and lender requirement. The due diligence fee, however, is generally nonrefundable unless the seller breaches; it is not a deposit to be returned just because the appraisal is low. The buyer's agent should confirm the contract's exact FHA clause and termination procedure, and provide written notice. If the contract has a separate appraisal contingency, that may also support return of earnest money.
3. What alternative should the agent present, and what risks must be disclosed?
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The cleanest alternative is to renegotiate the price to $285,000. At that price, the maximum loan is $275,025 and the buyer needs $9,975 down plus closing costs; the $9,000 seller credit could cover most closing costs, so the $12,000 cash may work. The seller may refuse. Another option is for the buyer to bring an additional $13,000, possibly as a documented gift from a relative if the lender allows gift funds for FHA. A second lien or other secondary financing is possible only if the lender approves and the payments fit ratios. The risk of proceeding without a price reduction is that the buyer must fund the gap, may deplete reserves, and could lose the deal if underwriting fails. The agent should not advise waiving the FHA clause without written lender guidance.