If you’re not aware of the VA Loan Escape Clause, it’s something you should definitely be aware of. While the Escape Clause is usually a much bigger pain point for the seller, the seller’s reaction can cause significant consternation to the borrower, to the extent that the seller may refuse to sell the home. As a VA Loan borrower, it is very wise to know exactly what the Escape Clause entails and to do your part to let the seller know ahead of time that the Escape Clause is coming and what it means.
So what is the Escape Clause? Well, the official VA language of the Escape Clause is as follows: “It is expressly agreed that, notwithstanding any other provisions of this contract, the purchaser shall not incur any penalty by forfeiture of earnest money or otherwise or be obligated to complete the purchase of the property described herein, if the contract purchase price or cost exceeds the reasonable value of the property established by the Department of Veterans Affairs. The purchaser shall, however, have the privilege and option of proceeding with the consummation of this contract without regard to the amount of the reasonable value established by the Department of Veterans Affairs.”
In plain speak, that means if the home’s selling price is higher than the VA appraisal determines to be the reasonable value of the home, the borrower can walk even if they have already signed a contract to purchase the home. To understand this provision fully, it is important to review the VA Loan process. A home buyer applies and gets pre-approved for a VA loan at a certain amount. Using that knowledge, they begin hunting for a home. A suitable home is found, the buyer makes an offer, and the offer is accepted (if only it was really that simple, right?). Then comes all the paperwork, both things that are common among all loan types and those that are VA loan specific. One of the VA Loan specific hoops to jump through is the VA appraisal, conducted by an official appraiser. One of the purposes of the VA appraisal is to determine the actual value of the home. After the appraisal, the VA will issue a Notice of Valuation (NOV) that states what the VA deems is the fair market value of the property. There’s just one tiny, little, miniscule issue here; this appraisal definitely takes place after the offer has been accepted and probably after a contract has been signed by seller and buyer for the agreed upon amount.
Why is this an issue? Because the VA absolutely will not guarantee a loan amount that is higher than what the NOV states is the fair market value. So…what if the buyer has already agreed to pay a certain amount that is higher than the VA is willing to guarantee? Enter Escape Clause. Once the NOV comes in, if the “fair market value” as determined by the VA is lower than the selling price, the buyer can still back out, or they can opt to pay the price and just have a portion of the loan not be guaranteed by the VA. In a lot of ways, this throws the seller under the bus, especially if the seller was not aware of the Escape Clause. Sellers often make important life decisions after the contract to sell their home for a certain amount is signed (since, you know, signing a contract usually establishes a legal obligation to fulfill the terms). Those important life decisions might become the worst things that ever happened to them if a buyer decides to walk out on a $300,000 contract. You can imagine why a seller might be downright irate if the Escape Clause slaps them in the face.
So as a potential buyer, what can you do to alleviate this? First, see what language your lender uses in the Escape Clause. The wording on a lender’s version of the Escape Clause might be subtly (but importantly) different from the official Escape Clause from the VA. A common adjustment is to change “…exceeds the reasonable value of the property…” to “…matches the reasonable value of the property…” This essentially gives the buyer the power to walk for any reason whatsoever as long as the sale value isn’t the exact same as the appraised value. If language like this is used, you can expect that a seller would rather de-list the home than sell it to a VA borrower. Knowing in advance what the lender’s Escape Clause states and making the seller aware as well can quite literally make the difference between getting your dream home and not.