Understanding the Home Appraisal Contingency

When buying a home, an appraisal contingency can serve as a safety net. If the home you want to purchase appraises for less than the price you agreed to pay, it gives you negotiating power with the seller. It also allows you to walk away from the deal without losing your deposit, should the seller not be willing to negotiate. 

In this article we’ll take a deeper look at what an appraisal contingency is and how it protects the buyer.

What Is a Contingent Offer?

A contingency is a condition that must be met before an agreement between two parties can proceed. When you submit an offer as a homebuyer, you have the option of including certain contingencies—and the seller has the option of accepting or rejecting the offer, along with the contingencies you’re proposing.

If the seller accepts your offer, along with its contingencies, then it becomes a contingent offer, which allows you to cancel the contract if the contingent conditions are not met. 

When your offer is accepted, you’ll pay an earnest money deposit that goes into an escrow account. This shows the seller that you’re serious about buying their home. The earnest money deposit is a percentage of your down payment and goes toward your down payment and closing cost at closing. If the sale does not go through because the contingent conditions were not met, then you’re entitled to receive your earnest money back in full.

In real estate, there are different types of contingencies. For example, a financing contingency states that you’ll purchase the home only if you’re approved for a mortgage or can acquire the funds needed to purchase the home. An inspection contingency states that you’ll buy the home only if it passes a home inspection. An appraisal contingency is also common with homebuyers. 

What Is an Appraisal Contingency?

When obtaining a mortgage to buy a home, it is common practice for your lender to require some sort of a home appraisal (desktop, drive-by, or full appraisal) to ensure the value of the home.

This is when an appraiser examines the property and looks at data on recent home sales and comparable homes in the area to determine its fair market value. After the appraisal is completed, the appraiser provides an estimate of how much the home is worth. 

Appraisal contingencies are often used by buyers who are obtaining financing. By adding an appraisal contingency, homebuyers can protect themselves by outlining the course of action they’re willing to take in the event that the appraisal comes back lower than the sales price. 

To learn more about the difference between appraised value and sales price, click here

How Does the Appraisal Contingency Protect a Buyer?

The appraisal contingency is written into the real estate contract to provide protection for the buyer. In today’s market, it can also provide options for how the buyer and seller will proceed if the appraised value of the home is less than the sales price.  

These options can include the buyer restructuring their financing or coming up with additional funds to pay the difference between the sales price and appraised value. 

Here’s an example of how an appraisal contingency could work in today’s market: If your real estate agent is concerned that the appraisal may come in below the sales price, you can write an appraisal contingency clause into the purchase contract stating that you will pay the difference between the contract price and the appraised value, up to a certain amount. 

The appraisal contingency can also give the buyer an option to walk away from the contract altogether if the deal cannot be restructured. 

What Happens When an Appraisal Comes In Low?

When the appraisal comes in lower than the sales price, and if you believe the value reflected is incorrect, there are some actions you and your real estate agent can take. Disputing the value and requesting a value reconsideration is typically the first step. 

In this scenario, the real estate agent can provide recent data or comps for the appraiser to take into consideration. The appraiser will look at the documentation provided and determine if an increase in value is appropriate. 

Another option is to request that a second appraisal be conducted on the property by a different appraiser. The seller may or may not be willing to contribute to the cost of the second appraisal if this is the agreed-upon route.

How Does an Appraisal Contingency Work When an Appraisal Comes In Low?

If the appraisal comes in lower than the sales price, an appraisal contingency gives you options. Clearly spelling out those options as part of your appraisal contingency is a good idea.

Here are a few possibilities:

  • Restructure your loan. In the current market conditions, with higher demand and lower housing inventory, this is something we’re seeing more of. Borrowers should work with their real estate agent and mortgage broker or mortgage lender to review all possible scenarios upfront. 
  • Make a larger down payment. Buyers may opt to increase their down payment amount to make up the difference between the appraised value and the sales price.
  • Go back to the negotiating table. Asking the seller to reduce the purchase price may be an option worth considering. If you can negotiate with the seller to lower the price to meet the appraised value, great. Or you can also ask them to meet you halfway. 
  • A combination of the above. If the difference between the sales price and appraised value isn’t too steep, you can ask the seller to reduce the price in addition to you making a higher down payment. If the decreased home price combined with your increased down payment make up the difference, then your lender may agree to issue the loan.

If none of these options work out, the appraisal contingency protects the buyer by allowing them to cancel the sale contract without forgoing their earnest money deposit.

When Should You Have an Appraisal Contingency?

Buyers who are obtaining financing to purchase a home should include an appraisal contingency with their offer. This is especially true for first-time homebuyers and buyers who are making offers on homes at the top of their budget with little down payment.

If the appraisal comes back lower than expected, having an appraisal contingency gives you peace of mind, and it provides options that would not be available if you did not have the contingency in place. 

Questions?

At Kairos Appraisal, we’re focused on providing a better borrower experience by engaging with the borrower right upfront to answer any questions you may have about the real estate transaction. Our 4.9-star average customer rating is attributed to our customer service, technology, and our talented team of appraisals.

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