Buying a home can be an expensive and risky proposition. You may not be familiar with the market in the area, or home values there can be hit or miss.
Once you’ve made an offer and it’s accepted by the seller, you’re both bound to the contract. As the buyer, if you back out for a reason not allowed by the contract, you’ll lose your earnest money deposit, which could be thousands of dollars.
That’s why an appraisal contingency is your ally: It will let you walk away from the deal with your deposit if the home doesn’t appraise for the amount you’ve agreed to pay.
What’s a Contingency?
Contingencies are conditions that must be met before a real estate contract is legally binding, and each includes a specified time frame.
Most purchase agreements include three contingencies:
- An appraisal contingency stating the home must meet the price you’ve agreed to pay (or higher) when appraised.
- A finance contingency stating that the deal depends on the approval of your loan.
- An inspection contingency requiring that the home pass a home inspection.
When Do You Need an Appraisal Contingency?
If a lender is involved, you’ll need an appraisal and should consider an appraisal contingency. “It’s an opt-out for the buyer who’s financing,” explains Susanna Haynie, a real estate broker in Colorado Springs. “If the home is not worth the price the buyer has agreed to pay, it can impact how much the lender is willing to lend and possibly the ability of the buyer to secure the loan.”
Cash buyers have an option to add an appraisal contingency to their offer and engage an appraiser, “But it’s not a third-party requirement,” says Haynie.
“Cash offers are king because they do NOT require an appraisal and can close quickly,” she adds.
Who Pays for the Appraisal?
Buyers normally pay for the appraisal and should consider them an extremely important part of the home buying process because the value determined by the appraiser is the maximum amount that can be loaned out by a mortgage company.
The lender will retain a state-licensed registered appraiser to determine the fair market value of the home. The appraiser arrives at that value based on the home’s general condition, location and comparative sales (or comps) in the area.
How Long Does an Appraisal Contingency Take?
Your lender or real estate agent can provide guidance on the timing for the appraisal contingency, but generally you should allow 2 – 4 weeks for the appraiser to visit the home and complete their report. “Different loans take different qualifications,” says Haynie. “And some seasons will be busier than others for the inspectors.”
If the value comes in higher than the sales price, everyone is happy, except maybe the seller, who might feel he should have asked for more. But if the appraisal comes in lower, things can get complicated.
What Happens if the Appraisal Comes in Low?
The deadline date for an appraisal contingency is the date by which any claims made by the buyer must be made. So, if the appraisal comes in too low, and there’s time, the buyer can petition for a second appraisal.
If you go this route, be sure to make the lender aware of reasons you think the home is worth more, such as recent comps the appraiser may have missed, or something of value that’s not really visible like radiant floor heating.
If the value is still too low, there are three options:
- The buyer can agree to bring more money to the table.
- The seller can reduce the price to meet the lower property value.
- The parties may agree to split the difference in any combination.
The contract may be terminated by either party if they can’t agree.
What Is an Appraisal Contingency Waiver?
This is where you agree to pay the full amount of the contracted price, even if the appraisal comes in low.
Waiving the home appraisal contingency clause is rare but there are exceptions. You might waive an appraisal if the determined higher or lower value does not have an influence on your ability to purchase the home and obtain the loan, which is usually the case of a large down payment. “This may be a great strategy and very beneficial in a multiple offer situation,” Haynie says.
But understand that you’re taking a risk. If the home appraisal is lower than the agreed purchase price, the contract is still valid, and you’ll be expected to complete the sale (or lose your earnest money or pay for other damages).
For example, if you’re seeking a $300,000 mortgage, but the appraisal comes in at $290,000, the mortgage lender is only able to finance $290,000. This leaves you to pay the remaining $10,000 out of pocket, as well as the down payment and other closing costs.
“In most cases, it’s best to keep the appraisal contingency in place,” Haynie says.
What Is an Appraisal Contingency Addendum?
An addendum is a separate form that, once signed by the buyer and seller, becomes part of the sales contract. Appraisal contingency addendums are state specific and allows a buyer to move forward with the purchase under certain conditions they agree to.
Do you have more questions about loan contingencies? Let us know in the comments below. And if you’d like to learn more about purchasing a home, start the process today!
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