VA Loan Rules: Mandatory Escape ClauseUpdated: November 9, 2022
The VA loan provides eligible borrowers with an outstanding home buying option with borrower protections. One clause that protects borrowers is the VA escape clause, which allows VA borrowers to walk away from a property if the appraisal comes back lower than anticipated.
Let’s talk about how the VA escape clause functions and what buyers and sellers need to know about it.
Most borrowers who are eligible for the VA loan understand the program’s benefits. But, not all home sellers are familiar with the VA loan. As a government-backed mortgage, the VA loan offers the following outstanding terms:
- No down payment required
- No private mortgage insurance (PMI) required
- Low interest rates
- Streamlined refinancing option via the Interest Rate Reduction Refinance Loan (IRRRL)
But, these advantages come with some strings attached. In particular, the VA loan program promotes homeownership, not investing.
Accordingly, the VA takes measures to protect borrowers’ best interests during VA home loan purchases. For example, the VA does not want borrowers to take out loans for more than homes are worth, which leads directly into the next section.
The VA doesn’t lend money. Instead, it insures VA loans made by lenders approved by the Department of Veterans Affairs. Despite this system, the VA still must approve every VA loan.
A VA-approved appraiser will complete a property appraisal during the VA loan underwriting process. The appraiser will inspect the home’s physical condition to confirm it meets the VA’s minimum property requirements.
But, the VA home appraisal primarily determines an accurate market value for the home.
For example, a buyer and seller may agree on a $250,000 home sale. But, if the appraiser determines that the home’s value is actually $200,000, the VA will not approve the loan.
The VA wants to protect borrowers from saddling themselves with more debt than a home is really worth. The VA also does this to protect itself. If a borrower defaults on a home loan, the VA does not want to pay a lender more than a home is worth.
The VA formalizes its view on property appraisals in any purchase contract.
If a buyer uses a VA loan, the purchase contract must include the VA’s mandatory escape clause, which directly addresses this scenario.
The VA escape clause addresses what happens when a VA property appraisal determines a home value is lower than the contract purchase price. When this happens, the escape clause states that buyers can back out of the deal without penalty. That means you can leave the deal and still keep your earnest money deposit.
For sellers, this may seem overly restrictive. However, the VA’s formal mandatory escape clause doesn’t materially change purchase agreements for many home sellers.
According to a December 2021 transaction survey by the National Association of Realtors, 81% of homebuyers insisted on an appraisal or inspection contingency in their purchase agreement.
Appraisal contingencies are similar to a VA escape clause. They allow non-VA home buyers to back out of a deal and keep their earnest money if a property fails to appraise at the contract price.
While the VA escape clause allows you to exit a deal without penalty, it doesn’t require you to terminate the contract.
VA borrowers can continue with a home purchase regardless of the VA’s appraisal, but the VA will only approve financing up to the appraised value.
Let’s say the sellers from our earlier scenario still want to purchase the home, despite the $200,000 appraisal coming in $50,000 lower than the $250,000 purchase price. In this situation, the VA would provide financing up to $200,000 – the appraised amount. Then the buyers would need to pay the difference in cash at closing.
But, buyers who are sticking to a predetermined budget can leverage their VA appraisal to negotiate a better deal with the seller. While sellers may not lower their prices to the home’s exact appraised value, they may be willing to split the difference with you.
If the seller in our example agreed to drop the purchase price to $225,000, the buyer could finance $200,000 with a VA loan. Then, the buyer would only have to pay $25,000 cash to close the deal.
In competitive markets, paying cash at closing might make sense, but for some buyers, it negates the VA home loan’s primary advantage: no down payment.
What Sellers Need to Know About the VA Escape Clause
Sellers must adhere to VA loan rules, including the mandatory escape clause. But, this shouldn’t dissuade you from working with a VA loan buyer.
Remember, the VA’s mandatory escape clause simply formalizes appraisal contingencies that are already in at least 80% of home purchase contracts, according to the NAR’s December 2021 transaction survey.
Additionally, VA loan purchasers successfully close on home purchases at a higher rate than non-VA peers, making them more reliable buyers. In June 2021, 70% of VA loans reached closing, compared to 51% of all mortgages, according to Ellie Mae, a mortgage application software company. While no closing is guaranteed, higher closing statistics may give sellers more confidence when closing with a VA home loan buyer.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.