The Importance of the Appraisal Contingency
Appraisal contingency is a clause in a purchase contract that lets buyers back out without losing earnest money. Waiving appraisal contingency when buying a home can be a big mistake.
Why Appraisals Are Needed
Appraisals help to determine a home’s fair market value. Listing prices do not always reflect market reality. When a buyer makes an offer on a home that’s higher than the actual market value, this is what’s known as an appraisal gap. Common reasons for appraisal gaps include:
- An up-and-down market with constantly changing home values.
- An extremely inflated local market.
- Overpricing by the seller.
- A unique or custom property lacking comparable properties in the area.
- A high number of short sales and foreclosures in the neighborhood.
- Inaccurate property records.
- Inexperience on the part of the appraiser.
An appraisal gap can make buying a home at the current asking price impossible for most buyers.
Appraisal Contingency Explained
An appraisal contingency allows the buyer to back out if the home is appraised for less than the purchase price in the contract. Buyers need this protection when using financing to purchase homes because lenders won’t provide mortgages larger than a home’s worth.
This policy is in place because it increases a lender’s odds of getting money back in the case of a foreclosure.
Even cash buyers are protected by this contingency because it stops them from purchasing an overvalued house.
How an Appraisal Contingency Works in a Purchase Contract
The buyer and their agent insert an appraisal contingency into a purchase offer. The appraisal contingency clause notifies the seller that the buyer will be having the property appraised as part of the mortgage process. If the appraisal falls short of the asking price, the buyer can back out without losing their earnest money deposit. The clause also protects the buyer from other legal actions.
The Process for a Home Appraisal
In most cases, the lender providing the buyer with a mortgage hires an appraiser. An appraiser is a licensed professional tasked with evaluating a property. They use recent sales data from comparable homes in the same area to come up with a number. After the appraisal, the appraiser reports their findings to the buyer and lender.
There is no benefit for the appraiser to be swayed in any direction. They simply serve as a neutral expert.
You Can Waive Appraisal Contingency
Buyers who purchase homes with cash can choose to waive the appraisal contingency. This is fairly common in competitive markets because it makes a buyer more appealing. For the seller, an appraisal that comes in too low can create a big problem that can ultimately prevent or delay closing. When looking at appraisal waiver pros and cons, these are the pros:
- Helps buyers in a bidding war.
- Speeds up closing.
- Reduces closing costs.
- Can be used as a negotiating tool for a lower offer.
The best candidate for waiving the appraisal is a buyer who knows that they really want a home. Regardless of the actual appraised value of the home, the home holds a specific value to the buyer due to its location, price point, features, and more. Here’s a look at the cons of going with no appraisal contingency:
- Buyers risk paying for an overvalued property.
- If the house needs to be sold by the buyer, they may sell at a big loss.
While appraisal contingency removal is essentially limited to cash buyers, there are rare exceptions. Some lenders waive appraisals if a home’s market value has been calculated very recently.
What to Do If the Appraisal Is Too Low
If an appraisal is lower than a buyer’s offer, the buyer should request a second appraisal. Coming with the right information can help persuade the lender to give an appraisal redo the green light.
Proving recent data on local home sales, proof of recent improvements in the home in question, and other details may improve the odds of being granted a second appraisal.
A buyer can also consider covering the appraisal gap with cash. This can mean putting down a larger down payment. Finally, asking the seller to lower the price to the appraised value may be a mutually beneficial option.
A seller refusing to alter the asking price will likely encounter the same issue with the next offer unless they can find a cash buyer.
Finally, buyers need to be prepared to let the clause do its intended job by allowing them to walk away from the deal after being refunded their earnest money deposit. While it’s not the conclusion most buyers are looking for, it can be the most financially sound option when the seller won’t budge on price.
The Appraisal Contingency Is Separate From the Mortgage Contingency and Inspection Contingency
Making an offer contingent on appraisal doesn’t protect you against issues tied to inspections findings or financing complications. You need separate contingencies for those.
A mortgage contingency allows the buyer to back out unscathed if they cannot obtain financing for the home purchase. Buyers aren’t locked in until receiving the final approval letter from the mortgage company if they activate this contingency.
It’s not unheard of for buyers to be approved for less than their prequalification or preapproval totals when applying for real mortgages.
An inspection contingency allows the buyer to back out if the home inspection uncovers serious defects. This can include foundation issues, structural damage, mold, or severe pest infestations. Inspection contingencies give the buyer power to either negotiate with the seller or walk away once these problems come to light.
Final Thoughts on Appraisal Contingencies in Today’s Market
The bottom line is that waiving an appraisal may help a buyer to get their offer accepted. However, the buyer will lose their earnest money deposit if they need to rescind the offer due to the home being overvalued.