Appraisal Contingency - The Comprehensive Guide

An appraisal contingency is a legal setup to protect you financially while making an offer on a home. It helps you make a better choice. This guide will explain what is an appraisal contingency and its importance during the home-buying process. An appraisal contingency is included in standard real estate contracts, so that you will see it almost everywhere. 

What Is An Appraisal Contingency?

A contingency is a contract condition that should be fulfilled to make it legally binding. It allows an easy, legal escape or "undo" button. The buyer can cancel the deal if a condition isn’t met within a time frame. Not only will the buyer get back their security deposit, but it may also contain compensation for the buyer's trouble.

An appraisal contingency stipulates that the property's appraisal value must be equal to or greater than the offered sale price. If not, the buyer can exit the deal with earnest money. For example, if you buy a house on loan, the lender will require a professional appraisal before funding the loan. As a result, you may not get the desired loan amount if the home appraisal is less than the offered price. If you withdraw from the agreement, you may lose your earnest money or face legal consequences without appraisal contingency.

An appraisal contingency is helpful for anyone. However, it is vital for first-time home buyers because they are more vulnerable. There are also other contingencies available for real estate deals. For example:

• The Finance Contingency states that the agreement is subject to the availability of a loan.
• The Inspection Contingency wants the home to pass a specific inspection. Also, if it needs repair, the seller should get it repaired, or it should be less than a particular amount.
• A Home Sale Contingency allows the buyer to sell their current property at location X within Y amount of days for the deal to be effective.

Homeowners Insurance Contingency adds that the buyer must be able to obtain homeowner insurance for the deal to be active.

Why Is The Appraisal Contingency So Important?

The price of a house before the appraisal is a guess only. If the lender agrees to pay the loan for that house, it may not be valid after assessment. For example, suppose the lender agreed to pay a $300,000 loan. Now the property is worth $260,000 in appraisal. However, the lender will only pay $260,000. Therefore, the buyer has to pay an additional $40,000. If the buyer does not have that money or does not want to add this money, then they might need an exit. This legal clause provides this safe escape. That is why appraisal contingency is so important.

How Do Appraisal Contingencies Work?

While processing your loan, the lender will order a home appraisal. First, an expert licensed appraiser will thoroughly examine to determine the value of a home. The examination includes checking the property and surrounding area to calculate the fair market value. Then the appraiser will give a professional opinion about the home price. 

If the appraisal is lower than your offer, the lender will not approve the loan. It is because lenders depend upon appraisers to avoid risk. For example, if they have to foreclose the property in the future, they will have a better chance of getting their money back. Thus In case of a lower appraisal, you have to negotiate with the seller for a lower sale price. They might agree if the market is not moving in the seller's direction. However, if they disagree, you can get out of the deal if you have an appraisal contingency. 

Thus an appraisal contingency gives you leverage during price negotiation. You can walk away from the deal with your deposit if the talks fail. You must either act upon the contract or face legal consequences if there is no contingency. The minimum price to walk away will be losing your earnest money. Thus, although an appraisal contingency is not required, it safeguards you in case of a lower appraisal.

When Do You Need An Appraisal Contingency?

Your lender might require an appraisal contingency. The lender might refuse the loan if the home is not more than or equal to the contract price. In some cases, the lender might agree to lend a lower amount. If you don't have the additional cash and the seller is unwilling to lower the price, you must walk away from the deal. It is only possible with this contingency in place. Thus, in the case of financing, you almost always need it. Adding an appraisal contingency is a good idea if you are cash-buying a home. However, no party will demand it in this case. You can consult your realtor to add or skip this contingency, depending upon the market condition.

How Does An Appraisal Contingency Protect You?

An appraisal contingency protects you from overpaying the price. The seller can ask for any amount for their property. You are not an expert in determining a property's accurate value. Only the appraiser can decide that. Thus, if there is a big difference between the asking price and the home's market value, you need protection. The appraisal contingencies save you from a wrong decision. You can get out of a deal if necessary without losing anything.

What To Do If The Home Appraises For Less Than The Offer?

If the home appraises for less than the offer, you can basically have four options. Let us explore.

Pay The Price Difference

You can add to the down payment if you have the money and believe the house is worth the price. The lender will base its mortgage on the appraisal value, but they are not at risk because you are paying up the difference. 

Renegotiate The Price With The Seller

Renegotiating the price with the seller might be the best path if successful. However, you need a seasoned real estate agent to deal successfully with the seller.

There are many reasons why a seller would agree to a lower price. For example, the seller might want to get rid of the property, or they are short of time, or the market is not suitable for them, etc. However, if the seller has many buyers in line, they might walk away.

You And The Seller Meet In The Middle

There might be a situation where the seller agrees to lower the price a bit, and you upsize your down payment. A win-win arrangement is also possible. 

Get Away From The Deal

Use this option if the seller is not lowering the sale price and you don't have the cash to make up or don't want to do that. Due to appraisal contingency, you will get your deposit back without any legal issues. Without it, you might lose your earnest money and face legal action. However, if you have added a loan contingency and your lender refuses to fund the mortgage due to a lower appraisal, you can still get out of the agreement without legal impacts.

FAQs About Appraisal Contingencies

While appraisal contingency is a common real estate term…many people are unfamiliar with it. Your realtor will likely include it in the contract, but you need details if you sell by owner. Here are some FAQs related to appraisal contingencies.