When buying a home, it is not unusual to want to pay the fair market value for the property. If you are getting a mortgage to purchase a house, the lender will also feel the same way.
Lenders don’t want to loan more money than an asset is worth. The way to avoid having appraisal problems is to have an appraisal contingency in your real estate offer to purchase agreement.
An appraisal contingency is an agreement between the buyer and seller that allows for the third-party appraisal to be performed. In the event the licensed appraiser determines that the property is worth less than the agreed-upon sale price, the buyer will have the option of terminating the agreement.
When that happens, the buyer will be able to get their earnest money deposit back.
Sometimes there is a specific agreement called an appraisal contingency addendum that explicitly states the appraisal guidelines. Let’s look at everything you need to know about appraisal contingencies.
What is a real estate appraisal?
An appraisal is performed by a licensed appraiser who is hired by the buyer’s lender to determine the property value. The appraiser will visit the home to analyze the property against other like properties that have sold in the last three to six months.
The “comps” used by the appraiser need to be the most comparable to the subject. They will look at things such as the style of home, the square footage, the number of bedrooms and baths, the condition, the amenities, the lot and the location.
All of these pieces of information will go into creating an appraisal report. The appraiser will make adjustments from house to house before ultimately arriving at the current fair market value.
Sometimes there will be issues that could impact the appraisal value.
What is an appraisal contingency?
An appraisal contingency can be both written and implied. As mentioned above, a contingency addressing the appraisal can be written into the sales contract. An implied contingency occurs when a buyer is getting a loan from a mortgage lender.
A lender does not have to grant a mortgage commitment to a borrower when the home appraisal comes in less than the agreed-upon sales price. The lender can, however, offer to finance a lower amount, which may not allow the buyer to escape the contract.
So, an appraisal contingency and a financing contingency are not the same things. Let’s have a look.
Appraisal contingencies are different from mortgage contingencies
The mortgage contingency could potentially cover the same risks as the appraisal contingency, but it might not. When a home doesn’t appraise at the offer price, the lender could refuse to grant the mortgage. In this circumstance, you can usually exit the sale with your earnest money.
However, it is also possible that the lender could agree to a lower loan amount that still meets the mortgage contingency clause. The seller could then demand that the buyer pays the difference.
When a buyer does not have the available funds to bridge the gap, they would be in default under the contract. In this circumstance, they would lose their earnest money.
When it is a buyer’s market, appraisal contingencies become far more commonplace. The opposite is true in a seller’s market. In fact, in hot real estate markets, there is often language inserted into real estate contracts that explicitly states that the buyer will come up with additional funds if the appraisal comes in low.
It’s referred to as an appraisal gap clause. It is commonplace to see them because many homes end up in bidding wars and sell way over the asking price. Home sellers never want to see their sale fall through because of an appraisal issue.
In order to make a buyer’s offer more attractive, buyer’s agents will add an appraisal gap guarantee. Some buyers will waive the appraisal contingency altogether.
The market will often dictate what to do
Whether or not you have an appraisal contingency in your contract will often be dictated by the current real estate market. Talk to your real estate agent about what is typical. If it is a strong seller’s market, it might be worth waiving.
On the other hand, if it is a buyer’s market and property values are dropping, you may want to protect your financing interests by having the appraisal contingency clause.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 35 years. Bill is the owner and founder of Maximum Real Estate Exposure. For the past decade, he has been one of the top RE/MAX REALTORS® in New England.
