What is an Appraisal Contingency? — Best Guide for Homebuyers

 

About Appraisal Contingency

If a home is appraised for less than the purchase price included in the contract then there is a provision that is included in the purchase contract allowing homebuyers to back out of their contract this is termed as an appraisal contingency clause.

Buyers who use financing to buy a house or are buying homes in areas where prices are volatile commonly use Appraisal contingencies.

How do Appraisal Contingencies work?

Purchase offers have appraisal contingencies inserted into them to notify the seller that the buyer intends to have the property appraised as part of their purchase for the financing process.

If the property doesn’t appraise for the amount the buyer offered to pay then this contingency allows them the option of backing out of the contract without losing their earnest money deposit or facing other penalties.

During an appraisal, a licensed professional is hired by the homebuyer to examine the property and evaluate it against the recent sales of comparable properties in the same area.

A report of their findings is given by the appraiser to the buyer and their lender.

With a home appraisal, an objective value is assigned to a property that’s being purchased. As most lenders aren’t allowed to lend more against a property than it’s worth so an appraisal is very important.

That way, in case of default the lender has a better chance of getting their money back if they have to foreclose.

If a buyer doesn’t intend to have a property appraised then the appraisal contingencies also can be waived.

Appraisal contingency waiver makes offers stronger for the sellers because it means the buyer doesn’t need the property to appraise for a certain value in order to close.

The Difference Between an Appraisal Contingency and a Mortgage Contingency?

A home buyer has the option to back out of a purchase contract if a property fails to appraise for a certain amount in an appraisal contingency.

Even in a mortgage contingency, the buyer has the opportunity to back out of a contract but only if they aren’t able to secure a certain amount of financing at terms the buyer finds agreeable.

Options in case of a Low Appraisal

According to the appraiser’s report if a property is appraised low it means that the home is not as worthy as the price included in the purchase contract, it can be problematic for the buyer who is using a loan to finance their purchase.

When underwriting loan lenders want to know if the property securing the loan is worth the purchase price and if the home appraises for a lower price, then the options are:

Buyer’s Option:

There are several steps that a buyer can take like:

• they can get another appraisal, a second opinion to confirm and adjust the home’s appraised value.
• The buyer also could offer a larger down payment which would be equal to the down payment they were planning to make and the difference between the purchase price to the home’s appraised value.
• Buyers can negotiate with the seller to reduce the purchase price to match the appraised value.

If none of these options work, then the buyer can back out of their purchase contract with no penalty because of the appraisal contingency.

Seller’s Option:

• Sellers have the option to renegotiate the purchase price of their home, as comparable sales in their area and appraisal do not support the purchase price listed in their contract.
• Sellers could also fix the problems noted by the appraiser and work towards reversing the appraised value.
• Sellers can offer to cover part of the purchase price not covered by the buyer’s down payment by helping the buyer by extending seller financing which is a mortgage between the buyer and the seller that doesn’t involve a bank or lender.

How to know that an Appraisal Contingency is not needed?

If the buyer is paying cash for a property or making a large down payment they may decide to strengthen their offer by waiving this contingency in their purchase agreements.

Instances, when a buyer may waive appraisal contingencies, are:

• The buyer is buying the property by paying cash.
• A buyer pays a down payment of above 20% to 25% of the purchase price.
• A buyer is purchasing property in order to redevelop it so the appraised value of the existing property is unimportant.

The buyer doesn’t have to find their own lender because the seller is offering to finance.

Conclusion

The clause of an appraisal contingency is included in purchase contracts when buyers are getting a loan to buy their house. Along with this contingency, there are others that are commonly used contingencies like:

Financing contingency: where if the buyer is not able to secure financing at agreeable terms they are allowed to back out of a contract

Home sale contingency: when a buyer has to sell another property before they can close on the purchase of a new house this contingency is applicable.

Title contingency: the title work for a property must come back clean, showing that the property is free of liens or other defects.

Inspection contingency: is when a property has to pass inspection.

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