What is an appraisal contingency and when should I use it?

A contingent offer on a house lets you back out of a purchase agreement if you learn something about the home (related to a contingency) that compels you to cancel the sale. Contingencies help ensure you’re not buying a home with major problems or paying more for a home than a mortgage lender is willing to finance.

It’s important to know the meaning of appraisal contingencies and how appraisal contingencies work when buying a home. You’ll need to consider different types of contingencies and whether you may need a particular contingency before making an offer on a house.

What is an appraisal contingency?

An appraisal contingency helps protect your finances when you make an offer on a home. A home appraisal determines the fair market value of the home you’d like to buy.

A contingency in real estate is a condition that must be met before an offer can proceed; they’re kind of like a safety net. If the home doesn’t appraise for the amount you’ve agreed to pay, you can walk away from the deal with your earnest money deposit.

Your real estate agent might recommend that you include one or more contingencies when you make an offer on a home. Contingencies aren’t individual contracts. Instead, they’re included alongside your offer. As part of accepting your offer, the seller has the option of accepting or rejecting your contingencies.

Appraisal contingency addendum

Often, there is a special, separate form outlining the specific appraisal contingencies that both buyer and seller will sign. This form is called an appraisal addendum, and they vary state by state.

How does an appraisal contingency work?

Your lender orders a home appraisal during your loan application, and a state-licensed appraiser takes a look at the house you want to buy as well as the area it’s in. The appraiser then gives you a professional opinion of how much the home is worth. Lenders require appraisals because they ensure that you’re not borrowing more money than your collateral (the home) is worth.

If the appraisal comes back lower than your offer you have a few options. You could try to ask the seller to lower the sale price, come up with the cash to cover the difference between the appraisal and your offer, or back out of the sale. You’ll have leverage in negotiating a lower price if you have an appraisal contingency.

Ultimately, you may have to walk away from the sale if you and the seller can’t reach an agreement. But, without an appraisal contingency, the option to walk away might not be available.

Appraisal contingency removal

If you decide to remove or waive appraisal contingencies, they must be removed in writing and signed by buyer and seller to complete the real estate transaction. This typically requires an appraisal contingency removal form.

How does an appraisal contingency protect you?

Appraisal contingencies protect you (and your lender) from overpaying for your home. More specifically, they protect you financially if there’s a serious difference in the home’s value and the purchase price you agreed to pay for it.

Waiving an appraisal contingency clause can make life extremely difficult for you if the home appraisal is low. You could be at risk of breaking the contract and losing your earnest money deposit.

What happens if the house appraises for less than the offer?

As mentioned, if the appraisal comes in lower than your offer, you and the seller have a few options.

First, if you believe the appraisal is wrong, you may petition for a second appraisal. Think of a second appraisal as a “second opinion” on what the home is worth. You need to have a reason why you think the first appraisal was wrong in order to get a second appraisal. Recent home sale data and documentation of improvements the owner has made may help improve your chances of getting a better second appraisal.

Was your second appraisal still too low? Your options include:

• Making a larger down payment: If you can make up the difference between the appraised value and the sale price, your lender may still offer you a loan.
• Asking the seller to lower the sale price: Your lender will finance the loan if you can negotiate with the seller to lower the sale price to meet the appraised value of the property.
• Any combination of the two options above: You might want to meet in the middle of these two solutions if you really love the home. For example, if there’s a $20,000 difference in appraised value and your offer, you might agree to an increase of $10,000 in price and your seller might offer to reduce the sale price by $10,000.

When should i waive an appraisal contingency?

An appraisal contingency isn’t required for an offer letter. There are instances where it makes sense to include the appraisal contingency and others where it’s strategic to waive the clause. Here are some examples of situations where waiving appraisal contingencies seems logical.

You agree to pay the full amount

If you plan to pay the difference in full, you’ll need to consider making a larger down payment to cover the costs of the gap in the appraisal. An appraisal gap happens when a home appraisal is lower than an accepted offer, and this creates a gap in the home’s worth versus the amount you offered.

It’s a seller’s market

You may want to avoid using an appraisal contingency if you’re buying a home in a very strong seller’s market. A seller’s market often means multiple offers for a single home and that buying competition is high. You can strengthen your offer by waiving your appraisal contingency if you love a home and you’re willing to risk a low appraisal value.

You’re buying with cash

Cash sales don’t require an appraisal because there’s no lender involved. While an appraisal is always recommended, skipping it can make sense if you’re buying with cash.

You’re indifferent to the home’s current value

If you’re looking for a fixer-upper or developing a property for future investments, you may not care about the current value of the home. In this case, you might want to waive the appraisal contingency.

The bottom line

An appraisal contingency clause can help protect your finances when you find your dream home and want to make an offer. If the home appraises for less than the agreed-upon sale price, the appraisal contingency lets you ask the seller to lower the price or walk away from the sale.

Are you in the market for a new house? Get started on your mortgage application to know how much you can afford to pay for your dream home.