FHA/VA Financing and Refund of Earnest Money Deposit

QUESTION: I represent a buyer who signed a contract to purchase a condominium unit. In paragraph 5 of the Offer to Purchase (form 2-T), we checked the box to indicate  that my client intended to obtain an FHA loan to finance her purchase. My client paid a due diligence fee and an earnest money deposit. At the end of the due diligence  period, we believed that everything was going well with the loan application process. However, a few days before closing, the lender notified my client that the condominium  development did not meet FHA guidelines. We informed the seller that we could not close on the purchase, and asked the seller’s agent to return the earnest money deposit.  The seller refused to release the deposit. Under the FHA/VA Addendum (form 2A4-T), is my client entitled to a return of her earnest money deposit?

ANSWER: No. The FHA/VA Financing Addendum provides that in one particular circumstance, a buyer will have the right to terminate a purchase contract without forfeiting  the earnest money deposit: namely if the property does not appraise. Federal regulations grant this right to buyers without condition; therefore, there is no requirement that a  buyer exercise this right during the Due Diligence Period.

Here, however, the problem is not with the appraisal. A buyer’s ability to obtain financing is clearly part of the buyer’s due diligence process. Paragraph 4 of the Offer to  Purchase and Contract advises buyers to consult with their lender prior to signing an offer to assure that the Due Diligence Period allows sufficient time for the lender to  provide the buyer with sufficient information to decide whether to proceed with or terminate the transaction. Paragraph 4 also includes the following warning, in bold print, at  the beginning of paragraph 4: “Buyer’s failure to deliver a Termination Notice to Seller prior to the expiration of the Due Diligence Period will constitute a waiver by Buyer of  any right to terminate this Contract based on any matter relating to Buyer’s Due Diligence.” Here, because the buyer did not terminate the contract prior to the expiration of  the Due Diligence Period, the buyer’s failure to close would be considered a breach of contract, as a result of which the earnest money deposit would be paid to the seller  (see paragraph 1(e) of the Contract).