Understanding The Appraisal Contingency
An appraisal contingency can help you protect yourself financially when you find a home that you think is right for you.
We’ll teach you a little bit about the importance of getting an appraisal contingency before you buy a home. We’ll also go over the different types of contingencies and whether you may or may not need a particular type.
What Is An Appraisal Contingency?
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. Specifically, 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.
They’re important because they allow you to get any money back that you deposit if you find out 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. Contingencies help you ensure you’re not buying a home with major problems and that you can get financing for your purchase.
There are a few different types of contingencies. Let’s take an in-depth look at each one.
The Appraisal Contingency
Your lender orders an appraisal during your loan application and an 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 rough estimate of how much the home is worth. Lenders require appraisals because they ensure that the lender won’t offer you a loan that’s larger than the home is worth.
If the appraisal comes back low, you’ll likely have to ask the seller to lower the sale price. You’ll have more leverage in asking the seller for a lower price if you have an appraisal contingency. Ultimately, you may have to walk away from the sale and get your deposit refunded if you and the seller can’t reach an agreement.
The Financial Contingency
This protects you in the event that 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.
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.
A financial contingency gives you leverage that you can use to encourage the seller to lower the sale price, cover closing costs or perform repairs that make the home more affordable. 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 inspections. 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.
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 value between what the home is worth and what you pay.
What Happens If The House Appraises For Less Than The Offer?
When your appraisal comes back for more than you offered on the home, everyone is happy and your sale goes 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 options include:
- Make 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.
- Ask the seller to lower the sale price. Your lender will finance the loan if you can convince the seller to lower the sale price to meet the appraised value of the property. Lowering the price means less of a financial risk for the lender.
- Any combination of the two options above. You might want to meet your lender in the middle of these two solutions if you really love the home. For example, if there’s a difference in appraised value and your offer is $20,000, you might offer to bring $10,000 more to your lender and your seller might offer to reduce the sale price by $10,000.
Should I Opt Out Of An Appraisal Contingency?
An appraisal contingency isn’t required for an offer letter. There are some instances where it makes sense not to include one.
When Not Using An Appraisal Contingency Makes Sense
You may want to avoid using one if you’re buying when it’s a 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 waive an appraisal contingency if you’re buying your home 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 price of the home is right and you love the property.
When An Appraisal Contingency Is Necessary
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 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.
A contingency is a clause in an offer letter that tells the seller you’re only willing to buy under certain conditions. Financing contingencies state that you’ll only buy the home if you can secure a loan and inspection contingencies state that you’ll only buy if the home passes one or more inspections.
However, the most important one is the appraisal contingency.It states that you’ll only buy a home if its appraisal price is at or above the sale price. If your home appraises for less than the price you agree to pay, your lender won’t loan you the full amount of money. In this case, you can ask the seller to lower the price, you can offer more money or you can walk away from the sale. Appraisal contingencies are especially important because they allow you to keep your earnest money deposit if you and the seller can’t reach an agreement after a low appraisal.
They’re necessary in most cases, but they aren’t required. You may want to skip the contingency if you’re buying a home with cash or you’re in a seller’s market. However, it makes a lot of sense if you’re buying your first home or you’re on a tight budget.
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