Not all of us are fortunate enough to have the cost of a house sitting around in our bank account, just waiting to be spent on the home of our dreams. If that is you — sincere congratulations on your life choices! However, in most cases, a mortgage loan is necessary for such a hefty purchase.
Let’s say you are ready to move forward with an offer, and you have everything you need to apply for a mortgage. That’s great news, but the loan amount all depends on the home appraisal. If you submitted an offer that winds up higher than the appraisal, there’s a problem — you might not get your full loan amount financed. This is why an appraisal contingency is a vital part of the real estate contract when you’re getting a mortgage loan.
Now, let’s say you are in a position to waive the appraisal contingency. This could give you a competitive advantage if the property you’ve made an offer on is a hot ticket. Should you offer to waive the appraisal contingency if you can? What can you do if the appraisal comes in too low? Also — what does “appraisal contingency” even mean?
Read on for answers. We’ve consulted with top real estate experts with decades of experience to explain what an appraisal contingency is, how it comes into play, what are the options when a home appraises below the offer price, and whether or not it’s best to bake an appraisal contingency into your real estate contract.
How an appraisal contingency works
First off: what is an appraisal contingency?
A contingency in a real estate contract is a condition that must be met before closing on a home purchase. The appraisal contingency is a primary contingency that’s included to protect the buyer if the appraisal amount comes in lower than the purchase price.
Here’s the deal: the bank or financial institution providing the loan requires an appraisal report to determine the actual value of the house and set the loan amount, because they will only lend you a certain percentage of the home’s actual value. The appraisal is necessary to ensure that the buyer doesn’t overpay for the property and so the lender is confident that the value of the house will cover their lost investment if the buyer defaults on the loan.
“It’s a pretty valuable tool to allow the bank that is putting up the financing to understand that this property meets the criteria for that type of a loan,” says Peter Chicouris, a top real estate agent in St. Petersburg, Florida, with 27 years of experience, who’s sold 75% more single family homes than the average St. Petersburg agent.
If the appraisal is lower than the purchase price, the contingency is there as a safeguard. In this case, “the buyer has the right to immediately have the contract terminated and have the earnest money returned to them,” explains Chicouris.
“They’ll lose the price of the appraisal, but that’s not a big expense compared to them possibly overpaying for a property.”
If (and when) you should waive an appraisal contingency
There are times when waiving the appraisal contingency can be mutually beneficial to the buyer and seller, but that all depends on the buyer’s financial capabilities. If the buyer will need a mortgage loan and includes a finance contingency in their contract, it would be pointless to waive the appraisal contingency because the appraisal is how the loan amount is confirmed.
If there is a cash buyer who is able to purchase the property outright, an appraisal contingency isn’t necessary unless the buyer wants to confirm they aren’t paying more than the property is worth. Waiving the contingency could also strengthen the offer and beat out the competition on an in-demand property. Sellers prefer offers without an appraisal contingency because “that way they know that they’re not going to have any chances of the contract falling apart,” says Chicouris.
Essentially, if the buyer wants the house badly enough and has the means to pay cash for it — especially if there are multiple offers — waiving the appraisal contingency could win them the home.
When would a particular property warrant such a waiver?
Chicouris advises that buyers only consider waiving the appraisal contingency if they’re working with an agent “and the agent can validate the value of the property and maybe the future potential of the value.” Other reasons to waive the appraisal contingency could include a superior location, the potential for expanding or building onto the property — or you simply know it’s your dream home.
“It’s done all the time, especially in a place like New York, with so many offers made on the same property,” says Patrick Carmody, a real estate and insurance attorney with nearly 40 years experience, who works as consulting counsel for New York real estate development and design firm Wheelhouse.
Another instance when waiving the appraisal contingency could be a good option is when the buyer could make a large down payment. This way, even if the appraisal is less than the offer price, the loan amount would only cover what the buyer still owes and the financial institution might still agree to the loan. That said, always consult with your real estate agent and your lender before considering this option when you’re obtaining any form of financing.
What to do when a house appraises lower than the purchase price
Luckily, low appraisals don’t happen often. According to a home appraisal study conducted by the Federal Reserve Bank of Philadelphia in 2018, less than 10% of homes were appraised below the contract price. Chicouris backs up these findings: “Out of 25 deals a month, it maybe happens once every three months.”
However, for the low percentage of homes that do appraise below the purchase price, buyers have options with an appraisal contingency.
Option one: Ask for a second appraisal
If you can make a strong case that the property value is higher than the appraisal price, you can ask for a second appraisal. The lender hires the appraisal company, so the buyer can request that they hire a different appraiser for a second evaluation, providing the reasons why they believe the original appraisal is incorrect. Some of these reasons could include:
- Inaccurate information in the initial appraisal
- Less-obvious home features that were missed in the first appraisal
- Updated or improved features
- Comparable recently sold homes (comps) in the same area that were sold at a higher price than the appraisal
If the lender does not agree to arrange a second appraisal, some contingencies can include an option for the buyer to obtain another appraisal at their own expense.
As an alternative to requesting a second appraisal, the real estate agent has the right to submit a rebuttal to the appraisal company. The most powerful argument in appealing an appraisal is new, relevant comps provided by the agent. These can be used as leverage for the appraisal company to reconsider their appraisal.
“The buyer’s agent can run their own comparables and submit a rebuttal to see if maybe the appraiser made a mistake,” explains Chicouris.
Option two: Ask the seller to decrease the purchase price
Asking the seller to decrease the purchase price is a reasonable request. This is especially true if the home has been on the market for a significant amount of time; there is a likelihood that the next appraisal from a different buyer could also come in low.
For these reasons, sellers are often willing to meet in the middle and split the difference.
Option three: Pay for the difference yourself
To save the deal from falling through if none of the other options work, the buyer can make up the difference of the appraisal amount and purchase price by paying out of pocket. It’s not always the first or best option, but if you love the house and the deal is on the line, it might be worth it to you to make sure you wind up with keys in hand.
So, appraisal contingency or no appraisal contingency?
If you are financing your home, an appraisal contingency is strongly recommended to protect yourself from a low appraisal. With it, you can walk away from the contract with your earnest money deposit or use it as a bargaining tool.
On the other hand, without the appraisal contingency, a seller could be more likely to accept your offer over others if you’re able to pay cash or put down a large down payment. Consider all these factors before you send that offer.
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