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

If you're applying for a mortgage to buy a home, your lender will order an appraisal to determine the property's value. Since lenders won't let you borrow more than a home is worth, it can be a serious problem if the home appraises for less than expected or less than you agreed to pay for it. This is why many buyers include an appraisal contingency in their offer. It gives them a chance to cancel the sale if the appraisal comes in low, which can help you negotiate a lower price to keep the sale on track. You also can cover the difference yourself, if you can afford it, or cancel the sale and get back your earnest money deposit.

Learn more about how the appraisal contingency works, how it protects you if the appraisal is low, and when you might want to waive this contingency.

What is an appraisal contingency?

An appraisal contingency clause in your purchase and sale agreement requires a satisfactory appraised value to close the sale. If the home appraisal comes in lower than the sale price, the buyer can cancel the sale without penalty.

The appraisal contingency protects you from having to buy a home that's worth less than you agreed to pay for it. The ability to cancel the sale gives you some leverage with the seller to negotiate a solution. When faced with a lost sale, the seller may agree to a lower price. Alternatively, you may increase your down payment to cover the appraisal gap, which is the difference between what the home is worth and your offer.

How a home appraisal works

A home appraisal is a professional opinion of a property’s fair market value prepared by a licensed or certified appraiser. Appraisers generally consider a property's size, layout, amenities, and comparable recent sales in the area.

Lenders typically require an appraisal for a mortgage to ensure they can recover their losses if you default and they need to foreclose on the home. Your lender will base the loan amount on the appraised value, not the contract price, which is why a low appraisal can hurt your chances of getting a loan.

Appraisal contingency addendum

The appraisal contingency often is included in the purchase agreement, but sometimes it's in an appraisal addendum. An appraisal contingency addendum is a separate form that outlines the specifics of the contingency for the buyer and seller to sign. This form can vary from state to state.

Different terms you may see in the addendum include the minimum appraised value required to proceed and the timeframe for responding to appraisal results.

You should rely on your contract and the professional guidance of your real estate agent or attorney for specifics about these terms and the addendum.

How does an appraisal contingency work?

When a home appraises at or above the agreed-upon purchase price, your lender will base the loan on the lesser of the appraised value or the purchase price. In this case, the appraisal contingency is satisfied, and the transaction can move forward as planned.

The appraisal contingency takes effect when the appraisal comes in below the purchase price. Depending on the terms of your contract, you can try to negotiate a lower sales price with the seller, make a larger down payment to cover the difference, or cancel the sale and walk away.

If you have an appraisal contingency and cancel the deal because it's not met, you typically get back your earnest money deposit.

Other common contingencies include the financing contingency and the home inspection contingency.

How an appraisal contingency protects you

An appraisal contingency protects you from overpaying for your home and from needing to come up with more cash than you expected at closing. It provides leverage and flexibility if the appraised value does not support the agreed-upon price. An appraisal contingency also can ensure you get back your earnest money deposit if the contract terms and deadlines are met.

What can I do if the house appraises for less than the offer?

If the appraisal comes in lower than your offer, you have what's called an appraisal gap. This is when the appraisal is lower than the purchase price. Since lenders won't let you borrow more than a home's appraised value, a low appraisal can keep you from borrowing enough to complete the transaction.

“The reason this contingency matters is simple: Banks lend based on value,” says Kristina Allan, a REALTOR® and real estate appraiser in Henderson, Nevada. “If you agree to buy a home for $500,000, but it appraises for $470,000, the bank will lend based on $470,000. Without an appraisal contingency, you would have to pay the $30,000 difference yourself or risk losing your deposit.”

Although it is less common, an appraisal that comes in higher than the purchase price means that you have secured a great deal, in which you instantly gain more home equity than you anticipated.

You and the seller have a few options if the appraisal comes in low. Let's take a closer look at each of these strategies.

Renegotiate the purchase price

You can ask the seller to reduce the price to better align with the appraised value. The seller can agree, make a counteroffer, or refuse – depending on market conditions and motivation.

“Sometimes sellers will agree, especially if the appraisal supports the lower value,” Allan says.

Bring additional cash to the closing

You pay some or all the appraisal gap out of pocket to move forward if the lender will not increase financing. Note that, while this increases your cash requirement, it doesn’t increase the appraised value.

"This is a real option, but it requires the cash to be available and a conviction that the home is worth the higher price," says Andrew Lokenauth, a personal finance expert in Tampa, Florida.

Meet in the middle

Sometimes, buyers and sellers agree to split the difference to avoid the deal falling apart.

"Meeting in the middle is a negotiation where both buyer and seller absorb part of the gap," Lokenauth says. "Maybe the seller drops the price by $10,000, and the buyer covers the remaining $8,000 to $10,000 at closing. It works best when both parties want to close, but neither can absorb the full gap alone.”

Walk away if allowed by the contract

Your appraisal contingency may allow you to cancel the sale if the appraisal is too low, provided you follow the contract terms and timelines.

“In most cases, your earnest money will be returned to you,” Allen says.

Removing an appraisal contingency

Removing an appraisal contingency means you agree to move forward regardless of the appraisal.

If you decide to remove an appraisal contingency, it must be removed in writing and signed by the buyer and seller to complete the sale. This typically requires a removal of appraisal contingency form.

The timing also matters, as you need to ensure you have sufficient cash to make up the difference.

“I would only go this route if you have enough cash reserves to cover a potential gap and a real conviction about the property’s value – because once that protection is gone, any shortfall between the appraised value and the purchase price falls on you,” Lokenauth says.

When to consider waiving an appraisal contingency

Waiving an appraisal contingency is a strategic choice. You can waive the contingency to make your offer more appealing to the seller. However, doing so increases financial risk. That’s because you surrender a key protection if the home appraises for less than the purchase price.

Note that an appraisal contingency isn't required for an offer letter. There are instances when it makes sense to include the appraisal contingency, and others when it's smart to waive the clause. Here are some examples of situations where waiving appraisal contingencies may make sense.

Competitive market conditions

In a strong seller's market, properties often receive multiple offers, and sellers tend to favor offers with fewer contingencies. Waiving an appraisal contingency can signal confidence and reduce uncertainty for the seller, as the deal is less likely to fall apart due to a low appraisal. You may want to consider this move when inventory is tight and bidding wars are common, but you’ll have to live with the risk.

You have extra cash

Waiving the appraisal contingency is more realistic if you have enough cash to cover the gap. This option requires careful budgeting and comfort with higher out-of-pocket costs.

You’re paying with cash

Plan to pay for the home 100% with cash? Without a mortgage to worry about, you won’t be constrained by lender appraisal requirements. In this scenario, a low appraisal won’t matter as much because there is no loan to approve.

You’re focused on long-term ownership

Expect to live in the home for many years? If so, you may be less concerned about the short-term market value of the property. In this case, you may be willing to accept the risk of a low appraisal because you are focused on long-term use versus immediate resale or equity. But this approach assumes that you are comfortable paying more than the appraised value and understand that market values can change over time.

FAQ

Here are answers to common questions about the appraisal contingency.

Do buyers need an appraisal contingency?

Most buyers benefit from an appraisal contingency, especially when using a mortgage to buy a home. The appraisal contingency protects buyers from needing to come up with more cash if the appraisal comes in low. Buyers in competitive markets or those with extra cash may waive appraisal contingency requirements to strengthen their offer.

What happens to earnest money if the appraisal is low?

If your contract includes an appraisal contingency and the property appraises for less than the purchase price, you can typically walk away without losing your earnest money. But without this contingency, you risk losing your deposit if you cannot proceed with the purchase.

Can you still get a mortgage if an appraisal comes in low?

Yes, but it will depend on how you respond to the appraisal. When a home appraises for less than the purchase price, lenders typically base the loan on the appraised value rather than the offer price. You may need to renegotiate purchase price with the seller, bring additional cash to closing, or rely on an appraisal contingency to get out of the contract.

The bottom line on the appraisal contingency

An appraisal contingency can protect your finances if the home you want to buy appraises for less than the agreed-upon sale price. The appraisal contingency gives you the option to ask the seller to lower the price or to walk away from the sale. Keep in mind that low appraisals do occur – especially in fast-moving markets – and buyers often have multiple paths forward. But the good news is that buyers often have multiple paths forward to navigate this negative outcome.

Are you in the market for a new house? Apply for a mortgage today to know how much you can afford to pay for your dream home.