Table of Contents
What Is an Appraisal Contingency?
Appraisal Contingency Explained
Benefits of an Appraisal Contingency
Appraisal Contingency Example
Waiving vs. Using an Appraisal Contingency
Other Types of Contingencies
Appraisal Contingency Bottom Line
What Is an Appraisal Contingency?
An appraisal contingency is a clause in a purchase contract that states that the buyer’s offer is dependent on an appraisal’s results. When buyers use an appraisal contingency, they can back out of the purchase if the home appraisal is low.
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.
Appraisal Contingency Explained
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.
Benefits of an Appraisal Contingency
1. Protection for the Buyer
An appraisal contingency ensures that the buyer is not overpaying for the property and provides a way to back out of the deal if the appraisal is significantly lower than the purchase price. If the house doesn't appraise, the appraisal contingency creates an opportunity to renegotiate the purchase price or terms based on the appraisal results, potentially leading to a better deal for the buyer.
2. Financing Assurance
Most lenders require an appraisal to approve a mortgage. An appraisal contingency helps ensure the buyer can secure financing based on the property's market value. By including an appraisal contingency, the buyer will be able to get their good faith deposit refunded if the home doesn't appraise.
Appraisal Contingency Example
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.
Waiving vs. Using an Appraisal Contingency
1. 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.
2. 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 the home recently sold, the lender may grant you an appraisal waiver, in which case you won't need an appraisal contingency.
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.
Other Types of Contingencies
- Financing Contingency
- Home Sale Contingency
- Title Contingency
- Inspection Contingency
1. 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 to your loan being rejected, the financing contingency allows you to back out of the sale without facing legal consequences.
2. 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.
3. 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.
4. 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.
Appraisal Contingency Bottom Line
An appraisal contingency is a crucial safeguard in real estate transactions, protecting buyers from overpaying and ensuring that the property is worth the agreed-upon price. By including this contingency in the purchase agreement, buyers have the flexibility to renegotiate, cancel the contract, or proceed with confidence, depending on the appraisal results. This clause helps facilitate a fair and transparent transaction for both buyers and sellers.