An appraisal contingency is a clause in a purchase contract that states that the buyer’s offer is contingent on an appraisal’s results. Although you can work with a broker and pull comps to determine a rough valuation of a potential property, it’s impossible to know a home’s actual value until a licensed appraiser inspects it.
There are all kinds of unforeseen factors that may influence the value of a home. Perhaps some structural defect you’re unaware of or recent changes in the local housing market will impact the home’s value. You won’t know the exact value of a home until you have it appraised by an expert.
Most lenders will require you to have an appraisal done before they will approve your loan. Typically, they will only agree to lend you a percentage of the loan-to-value ratio based on the appraisal, not what you offer. For example, if you put down a 20% down payment, they may approve you for an LTV ratio of 80%.
If your offer is accurate, this will cover the remainder of the purchase. But if the appraisal returns lower than you expected, you may be required to pay the difference if you want to proceed with the sale. The appraisal contingency allows you to modify or rescind your offer if the appraised value is significantly lower than expected.
Say you find a great house in a perfect neighborhood, but it’s in a hot market, and there’s competition from other buyers. You confer with your broker and decide to make an offer that is $10,000 above the asking price to entice the seller, and they accept. Your bank has already approved you for an LTV of 85% with a 15% down payment.
You sign the purchase contract containing an appraisal contingency and schedule an appointment with an appraiser. But the appraiser reveals that the home has a mold problem, which will significantly impact the value.
They reveal that the asking price was $40,000 higher than the appraised value, meaning your offer is $50,000 higher. The bank will only lend you 85% of the appraised value. So, if your offer was for $250,000 and the home is worth only $200,000, the bank would only approve you for $170,000. Without an appraisal contingency, you’d be forced to pay the additional $80,000 out of pocket (including your down payment). But with the clause, you’d be able to make a counteroffer based on the new data or back out of the sale.
Times to Use an Appraisal Contingency
Most buyers purchasing a primary residence will want to use an appraisal contingency. Without it, you’ll be in a challenging situation if the appraisal comes back low and you don’t have the money to cover the difference. There’s little downside to including it in the purchase agreement, and most sellers expect it anyway.
Times to Waive an Appraisal Contingency
Although most buyers should insist on having an appraisal contingency, there are times when it may make sense to waive this right. For instance, if you’re paying cash and plan on demolishing or doing a total gut renovation on the existing home, you may skip the appraisal and close sooner. Or, if you are facing a ton of competition from other buyers and want to make your offer stand out, you may also choose to waive this right in exchange for a faster closing. But if you’re financing the purchase, be prepared to cover the difference out of pocket if the appraisal comes in low.
- Financing Contingency: A financing contingency allows the buyer to back out of the sale if the financing falls through. For instance, if you lose your job after putting in an offer, which leads your loan to be rejected, the financing contingency allows you to back out of the sale without facing legal consequences.
- Home Sale Contingency: Some buyers also choose to include a home sale contingency in the contract, allowing them to back out of the sale if their former residence doesn’t sell fast enough. You may be selling your previous home simultaneously and need to be sure you find a buyer so that you’re not on the hook to pay two mortgages.
- Title Contingency: A title contingency allows a buyer to back out or modify their offer if any issues with the property’s title are discovered. For instance, if someone other than the seller claims ownership of the property or there are unpaid liens against the title that weren’t discussed, the title contingency allows you to reconsider your offer.
- Inspection Contingency: The inspection contingency allows you to change or rescind your offer if a home inspection reveals something unfortunate. So, if you find out the roof is about to cave in, you can either request a credit to have it fixed or walk away from the sale.
The appraisal contingency is a standard clause in most purchase contracts, especially if you’re using a mortgage. It can save you from issues with your loan if the appraisal comes in low and allows you to renegotiate once you know the actual value. While it may make sense to waive the appraisal contingency in specific scenarios, most home shoppers are wise to include this clause in any contracts they sign.