What is an Appraisal?
Appraisals and appraisal contingencies are standard parts of most real estate transactions and the home-buying process.
A real estate appraisal is often conducted when purchasing a home and getting a mortgage. It ensures that you pay the fair market value for a property.
Appraisal is a requirement of mortgage lenders before they provide financing. They want to ensure that the asset they’re lending against has sufficient equity.
The home appraisal establishes a value based on similar properties sold in the same general area. The data used is called comps or comparable sales.
When homebuyers submit offers, the real estate contract often includes an appraisal contingency clause stating that the appraisal value must meet or exceed the contract price.
Contingency clauses protect buyers, so the bank has no issues granting a mortgage loan.
An appraisal is conducted by a licensed appraiser the lender hires. Based on their analysis, the appraiser will submit an appraisal report to the lender.
A buyer will also get a copy of the appraisal from the buyer’s lender.
What is an Appraisal Contingency?
An appraisal contingency states that the appraised value must equal or exceed the purchase price. This condition is often included in an appraisal contingency addendum attached to a purchase offer.
A contingency period, typically a few weeks, will be agreed upon in the purchase agreement to determine the home’s value.
An appraisal contingency clause can be added to real estate contracts, but it is also an implied condition for getting a mortgage.
In other words, the lender can deny buyer financing if a home does not appraise for a specific value. So, financing and appraisal contingencies are similar but not the same.
The contingency for an appraisal also protects the buyer from overpaying for a property when making an offer.
When working with a buyer’s agent, they need to perform a comparative market analysis to increase the chances of avoiding a low appraisal.
While a CMA and appraisal are different, they are both valuation methods. Research can help avoid problems in the home-buying process.
How Does The Contingency Work?
During the loan application process, your lender orders an appraisal of the home you want to buy. A licensed home appraiser then examines the house and its surroundings.
The appraiser will provide a professional opinion of the home’s value. Lenders require an appraisal to ensure that the house is not being sold for more than it is worth.
If the appraisal comes in lower than your offer, you may want to ask the seller to lower the sale price, come up with the cash to cover the difference between your offer and the appraisal or terminate the sale.
If you have an appraisal contingency, you’ll be in a stronger negotiating position with the seller. Without one, you might be unable to walk away from the sale without losing your earnest money. You’ll have a higher risk.
Contingency Clause and Addendum
When writing the sales contract with your real estate agent, there could be an appraisal contingency addendum. The language in this addendum states that the offer price must be equal to or greater than the home’s appraised value.
If you waive the appraisal contingency, it may make things difficult if the home’s appraisal is low. You could potentially lose your earnest money deposit, at the very least. Again, it is the mortgage contingency vs. appraisal contingency argument.
The contingency addendum form is commonplace for brokers to use in a purchase agreement.
Contingency Example
Below is an example of language to familiarize yourself with the contingency clause in a real estate contract.
To proceed with this transaction, the Real Estate must be appraised at a value equal to or greater than the final sales price. The buyer can hire a licensed appraiser to conduct an independent appraisal at their own expense. If the appraised value does not meet or exceed the purchase price, the buyer can cancel this contract by providing written notice to the seller within the specified time frame.
If the buyer does not provide written notice of termination before the appraisal contingency period expires, their right to terminate the contract based on the appraised value will be waived.
Vital Facts Buyers and Sellers Should Know
1. An appraisal contingency is a clause in a real estate contract that allows the buyer to back out of the deal if the property’s appraised value is lower than the agreed-upon purchase price.
2. Home buyers commonly use it to protect themselves from overpaying for a property.
3. The clause typically specifies a timeframe within which the appraisal must be conducted and any issues addressed.
4. If the appraisal comes in lower than expected, the buyer can request a price reduction or negotiate other terms with the seller.
5. In some cases, the buyer may terminate the contract altogether and receive a refund of their earnest money deposit.
6. Appraisal contingencies are less common in competitive real estate markets where bidding wars and inflated prices occur frequently.
7. An appraisal contingencies protect the buyer by ensuring fair market value is reflected in the purchase price.
8. Buyers should exercise caution when waiving or modifying the appraisal contingency, as this eliminates their ability to renegotiate or exit the deal based on the appraisal results.
9. Appraisal contingencies are a standard part of many real estate transactions. Still, it’s always essential for buyers and sellers to consult with a knowledgeable real estate agent or attorney to fully understand their rights and obligations.
What Does Waiving an Appraisal Mean?
Many home buyers will ask their real estate agent what a no appraisal contingency means. They usually ask because one of their friends is buying a home, and they hear the appraisal was waived.
Two parties can waive an appraisal – the lender and the home buyer. The lender often waives a review when they know the property has significant equity.
A buyer putting more than 20 percent down is often a candidate to have the appraisal waived. The lending institution feels well protected even if the buyer paid more than the fair market value.
The lender not requiring an appraisal can be a nice perk because home buyers pay for the assessment as part of their closing costs.
Buyers can also waive the contingency when offering a home. There are types of cases where it is wise to do so.
Waiving of appraisals happens often in a seller’s market that heavily favors homeowners. Buyers will waive the property assessment to make their offer more attractive to a seller.
Market conditions often dictate appraisal waivers. In a housing market with numerous bidding wars, buyers need every edge over their competitors.
Now more than ever, there is competition against cash buyers.
By waiving the appraisal, a seller is more confident that the deal will go through despite the low estimate. It also helps level the playing field with a cash offer.
With a waiver, the home’s appraised value becomes a non-issue. If the situation warrants it, you should waive your appraisal contingency.
What is an Appraisal Gap Clause?
The mechanism for waiving the appraisal is an appraisal gap clause. An appraisal clause is a language added to an offer to purchase that states the buyer will provide the difference between the purchase price and appraised value.
Some like to call it an appraisal gap guarantee. Let’s look at a real-world example so you can understand this better.
If a house is purchased for $700,000 and the appraisal is at $ 675,000, there would be a $25,000 difference from the contract price.
For the lender to feel comfortable financing a property worth less than the appraisal, the buyer must agree in writing to cover the difference. This way, there are no issues with the finance contingency.
The appraisal gap clause has become commonplace in most real estate contracts due to the extreme seller’s market. Buyers who disagree with appraisal gap language often lose out to other bidders.
Should I Waive The Contingency?
Whether you waive the appraisal contingency or not is a personal financial choice. If you’re not concerned about overpaying for a property, then by all means, you should waive it.
When you’ve been house hunting and losing out to other bidders numerous times, it probably makes sense to increase the attractiveness of your offer. It certainly makes sense when you have a sizeable down payment.
On the other hand, keeping the appraisal clause could be necessary if your finances are marginal and you don’t have the extra cash to make up a shortfall. Everyone’s situation is different.
Appraisals are more apt to be waived in a buyer’s market vs. a seller’s market.
Are There Any Other Alternatives When The Appraisal Comes in Low?
We also haven’t discussed whether you can challenge the appraisal. In rare circumstances, an appraiser will make a mistake.
They are human, just like the rest of us. Unfortunately, most appraisers don’t think they ever make mistakes, so fighting a low appraisal will be difficult.
You will need an exceptional agent who can challenge the value to fight and win an appraisal battle.
In my thirty-eight years of selling real estate, I’ve only had to challenge a low appraisal three times. Fortunately for my clients and me, I am hitting 1000. That’s rare.
Most challenges go nowhere, as appraisers have egos bigger than Hollywood stars. What I made a mistake? How can that be? This is what you would hear inside their head.
When fighting the appraisal, present your facts and the best comparable sales that prove the value. That’s the only way to win.
Lenders do not generally order a second appraisal, so that is not an option.
Other Common Real Estate Contingencies Worth Knowing
Besides an appraisal contingency, you should understand a few other common contingencies. If you’re a first-time home buyer, typical contingencies might not be something you’re entirely familiar with.
Let’s have a look.
Home Inspection Contingency
The home inspection contingency gives a buyer the right to hire a professional home inspector to look for defects in the property. The clause provides buyers a certain amount of time, usually seven to ten days, to conduct their due diligence.
If the buyer is dissatisfied with the inspection results, they can terminate the sale and request a refund of the earnest money. Alternatively, the buyer and seller may renegotiate the sales price based on the results, or the seller may offer a concession.
The inspection contingency is one of the most common aspects of a home purchase.
Mortgage Contingency Clause
Loans are one of the most common reasons a home purchase falls through.
Unless you’re paying cash for a house, a mortgage financing clause will often be part of your offer to purchase. The standard language in a financing contingency will state the buyer needs to procure a mortgage for a specific amount of money by a certain date.
The financing clause will also state what type of mortgage you’re applying for, such as a conventional loan, FHA loan, or VA loan.
If they cannot get a mortgage by that date, they can terminate the sale and have the deposit returned.
Buyers often ask for extensions, usually granted when they need more time to get a mortgage commitment.
Buyers must be careful about keeping their financing contingency active, or they could be in breach of contract. If that were to happen, a buyer would be open to making their earnest money deposit non-refundable.
Home Sale Contingency
Although rarer, a home sale contingency clause in a purchase contract gives the buyer the right to sell their home before moving forward.
Most sellers and their real estate agents frown upon accepting these clauses as they take away the control of the process and put it into the buyer’s hands.
Accepting a home sale contingency is rarely a good idea. A kick-out clause, which keeps control in the seller’s hands, may be acceptable.
Interesting Statistics About Contingency Clauses in Real Estate Contracts
1. Over 95% of home buyers in the United States include an appraisal contingency clause in their purchase agreements.
2. Approximately 78% of appraisals conducted under a contingency agreement result in a valuation within 2% of the agreed purchase price.
3. In competitive real estate markets, buyers who remove the contingency have a 13% higher chance of winning a bidding war.
4. Removing the contingency reduces the likelihood of a seller accepting a cash offer by 42%.
5. Home purchases involving an appraisal contingency are associated with a 23% lower foreclosure risk than those without.
6. Buyers protected by the contingency save an average of $8,500 on negotiated repairs and credits during inspections.
7. Loan applications that include the contingency are approved at 91%, surpassing the approval rate for applications without one by 6%.
FAQs
Here are some frequently asked questions about appraisal contingencies and their answers.
Who Pays For The Appraisal in a Typical Situation?
In typical situations, the buyer usually pays the appraisal fee. The mortgage lender hires a licensed appraiser to assess the fair market value of the property a buyer is interested in purchasing.
The appraisal helps the lender determine if the asking price aligns with the property’s value. Since the buyer benefits directly from this assessment, it is customary for them to cover the cost of the appraisal.
However, it’s important to note that specific arrangements can vary depending on local customs and negotiations between the buyer and seller.
Is The Contingency Good For a Seller?
No. It allows a buyer to back out of the sale when the appraisal is lower than the sales price.
Should Sellers Accept Appraisal Contingencies?
It depends. Is it a buyer’s or seller’s market? The contingency is far less common in a seller’s market than in a buyer’s. A seller will need to decide based on the circumstances of the transaction.
What Happens if I Waive The Contingency?
When the contingency is waived, you cannot exit the sale without losing your earnest money deposit if the appraisal is low.
How Long is The Contingency?
It is typically no longer than three weeks. The appraiser will usually complete the appraisal and report to the mortgage lender within three weeks of the offer to purchase.
Are There Any Deadlines for the Contingency Period?
Yes, there are typically deadlines associated with the contingency. To ensure a smooth and timely process, it is common for there to be specific timeframes outlined within the contingency.
These timeframes may include deadlines for scheduling and completing the appraisal and notifying the seller of any issues.
Both buyers and sellers must carefully review and adhere to these deadlines to avoid potential complications during the transaction.
Conclusion
The appraisal contingency clause can help protect your finances if you find the home of your dreams and want to make an offer. This clause allows you to pay for an appraisal if the sale falls through, preventing losses.
If the home appraises for less than the agreed-upon sale price, you can ask the seller to lower the cost, offer more money for the house, or walk away from the sale altogether.
Speak to a local real estate attorney if you don’t completely understand an appraisal contingency’s ramifications.
About the Author: Bill Gassett, a nationally recognized leader in his field, provided the above real estate information on an appraisal contingency and how it works. He is an expert in mortgages, financing, moving, home improvement, and general real estate.
Learn more about Bill Gassett and the publications he has been featured in. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. Bill has helped people move in and out of Metrowest towns for the last 38+ years.
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