What Is An Appraisal Contingency?

An appraisal contingency can help you protect yourself financially when you make an offer on a home.

We’ll teach you a little bit about the importance of getting an appraisal contingency when buying a home. We’ll also go over different types of contingencies and whether you may or may not need a particular type.

A contingency is a condition that needs to be met before an offer can proceed. In other words, it’s kind of like a safety net. Therefore, an appraisal contingency means that if your home doesn’t appraise for the amount you’ve agreed to pay, you can walk away from the deal with your deposit. An appraisal determines the fair market value of the home you’d like to buy.

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. Like your offer, the seller has the option of accepting or rejecting them.

What Is A Contingent Offer?

A contingent offer allows you to back out of your purchase agreement (and get any money back that you deposit) if you learn something about the home that makes you want to cancel the sale. You traditionally put some money down in an “earnest deposit” escrow fund when you make an offer on a home.

The earnest money deposit is a small percentage of your down payment that you put into a neutral account that tells the seller you’re serious about buying a home. That deposit goes toward your down payment if the seller accepts your offer. If the seller rejects your offer, you get your money back.

You have the option to rescind your offer and get your earnest money deposit back if you include a contingency in your offer and the condition isn’t met. On the other hand, if you don’t have a contingency in your offer and you later want to back out of the sale, you’ll lose the deposit you put in escrow when you made the offer, and you may still be legally obligated to purchase the home.

Contingencies help you ensure you’re not buying a home with major problems or paying more for your home that can be financed through a mortgage.

How Does An Appraisal Contingency Work?

Your lender orders a home appraisal during your loan application and a 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 the home isn’t selling for more than it’s worth.

If the appraisal comes back lower than your offer, you’ll either want 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 to you.

While an appraisal contingency is not required, waiving the clause can make things extremely difficult for you if the home appraisal is low. You could be at risk of breaking the contract and losing your deposit, at the very least.

There are a few different types of contingencies. Let’s take an in-depth look at each one.

The Mortgage Contingency

A mortgage contingency, also called a financial contingency or loan contingency, protects you if you can’t get funding for your mortgage. Under a financial contingency, you aren’t locked into your home sale until you receive a concrete approval letter from a mortgage company.

Mortgage preapprovals and prequalification aren’t set in stone until you get full approval. Many first-time home buyers make the mistake of thinking that their financing is set once they receive a preapproval. In fact, you may not be able to get as much funding as you originally thought if your financial situation has changed from the time since you got your preapproval.

You may be able to get your deposit back and walk away from the sale if you and the seller can’t reach an agreement and you aren’t able to get a loan.

The Inspection Contingency

An inspection contingency locks you into the sale contract only if the home passes an inspection. Inspections are more intensive than appraisals and give you a more in-depth look at what needs to be fixed or corrected in the home. Make sure you specify which types of inspections the home needs to pass.

Mold, pest and foundation inspections are all required. Your mortgage lender can help you understand which inspections are state-required and which are optional. For example, it’s important to get an inspection for lead-based paint if you want to buy a home built before 1978 and the home hasn’t had one in the past.

If the home fails inspection, you can negotiate with the seller to have the problem fixed. Otherwise, you can back out of the sale.

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 value between what the home is worth and what you agreed to pay for it.

When your appraisal comes back for more than you offered on the home, your sale moves forward. But what happens if the appraisal comes in lower than your offer? You and the seller have a few options under these circumstances.

First, if you believe that 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? Some of 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.

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 might be strategic to waive the clause.

When To Use An Appraisal Contingency

Most people should include an appraisal contingency with their offer, and if you’re buying a home for the first time, it makes a lot of sense. First-time buyers are less likely to know the ins and outs of the offer and home appraisal processes. An appraisal contingency protects you and your finances, which makes the first-time buying process easier and less stressful.

You should also include one if the home you’re buying is at the top of your price range. If you agree to a sale price and the appraisal comes back lower than expected, you’ll need to cover the difference. It motivates the seller to lower the price of the home and gives you a way out of the deal if you can’t reach an agreement with the seller.

When To Waive An Appraisal Contingency

You agree to pay the full amount of a home’s contracted price when you waive the appraisal contingency clause, even with a low appraisal value. In some cases, however, it makes sense to go forward with waiving an appraisal contingency.

You may want to avoid using an appraisal contingency if you’re buying a home in a strong seller’s market. A seller’s market means that there are multiple offers for a single home and buying competition is high. The seller can choose between multiple similar offers in a seller’s market.

Any offer with strings attached is less appealing to the seller. You can strengthen your offer by waiving your appraisal contingency if you love a home and you’re willing to risk a lower appraisal. Ask your real estate agent about local selling conditions and for advice specific to your area.

You may also want to forgo an appraisal contingency if you’re buying a house with cash. Cash sales don’t require an appraisal because there’s no lender involved. Skipping the appraisal makes sense if you’re buying with cash because you know the purchase price of the home is right and you love the property.

The 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 enables you to ask the seller to lower the price, offer more money for the house or walk away from the sale entirely.

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