Using TREC’s Right to Terminate Due To Lender’s Appraisal Addendum
The Texas Real Estate Commission (TREC) Addendum Concerning Right to Terminate Due to Lender’s Appraisal is used to modify the base TREC contract regarding contract termination rights based upon the appraised value of the purchased property. This form has three options, two of which waive or partially waive the right of the buyer to terminate based on the appraised value of the property and one which gives the buyer the right to terminate if the property appraises for less than a specified amount.
First Option. The first option, entitled “Waiver” waives the right of the buyer to terminate the contract if the lender determines that the appraised value does not meet its underwriting requirements. If the lender reduces the loan amount due to a low appraisal, the buyer must contribute any additional cash needed to complete the purchase. Of the three options, this option creates the most risk for a buyer. If the buyer cannot or chooses not to close, he or she will be in breach of the contract and subject to the remedies available to the seller as discussed below.
Second Option. The second option, entitled “Partial Waiver” can protect a buyer by limiting the additional cash required for the purchase. However, achieving that result is not as easy as it might seem because it requires a mathematical computation.
The form only allows a buyer to insert a minimum appraised value. There is no option to limit the cash the buyer must bring to closing. However, this result is achievable, but it requires a mathematical calculation. By using the formula Sales Price – (Additional Cash/LTV%) = Paragraph 2(ii) minimum appraised value a buyer can calculate the minimum appraised value required to limit the cash required to close.
Consider this example. Assume a sales price of $500,000 with an 80% loan of $400,000 and a down payment of $100,000. Further assume the buyers have an additional $10,000 in cash which they are willing to invest to acquire the home if it does not appraise for the sales price.
The above formula will calculate the minimum appraised value to limit the buyers’ cash requirement to $110,000. Using the example above $500,000 – ($10,000/80%) = $487,500 as the minimum appraised value needed to limit the cash investment to $110,000 assuming the lender will loan 80% of the appraised value of $487,500. That results in a $390,000 loan with the buyer contributing $110,000 in cash.
Third Option. The third option, entitled “Additional Right to Terminate” provides the most protection for the buyer. Besides the right to terminate under Paragraph 2B of the Third-Party Financing Addendum, the buyer can specify a minimum amount for the appraised value and terminate if the property appraises for less than that amount.
A buyer should understand the risks assumed before using this addendum. If the appraised value requirement is waived and the buyer is unable or unwilling to invest the additional cash required to close, the buyer cannot close the purchase and will be subject to the full range of remedies available to the seller including a suit for specific performance, a suit for damages, or the election to retain the earnest money.
A buyer should not assume that the only risk is loss of earnest money. When a buyer agrees to purchase at a price above the appraised value, a suit for damages becomes much more attractive to the seller. Assume a buyer agreed to pay $600,000 for a property which appraised for only $550,000 and was sold for that amount to another buyer. The defaulting buyer could be liable for the difference between what he agreed to pay for the property and the price for which it was sold which would result in a judgment for $50,000 in damages, plus the attorney fees incurred by the seller, plus the attorney fees the buyer paid to the law firm defending against the lawsuit.
A buyer must carefully assess the risks before waiving the right to terminate based on the appraised value.