When a buyer and seller agree to a real estate contract, it typically includes one or more contingencies. Those are terms that have to be met for the contract to be binding and for the transaction to proceed. One common provision is an appraisal contingency.
What Is an Appraisal and Why Is It Important?
An appraisal is an independent assessment of a property’s value. Sometimes, several buyers get locked in a bidding war, and the final price that a buyer and seller agree upon is higher than the list price. Making a high bid can help a determined buyer beat out the competition, but it can backfire.
If the buyer needs to take out a mortgage, the lender will require an appraisal. The company doesn’t want to give a homebuyer a loan for more than a house is worth. If a home appraises for less than the agreed-upon sale price, a mortgage lender can refuse to approve a buyer’s loan application. The contract will specify how much time the buyer has to get the property appraised and to notify the seller of a problem.
What Is an Appraisal Contingency?
An appraisal contingency is a clause in a real estate contract that gives the buyer the right to back out of the deal if the house appraises for less than the price the two parties have agreed on. In that case, the buyer won’t face any legal consequences and may be eligible for a refund of any earnest money that has been put in escrow.
What Can Happen If a House Appraises for Less Than the Sale Price?
The buyer doesn’t necessarily have to walk away if the home’s appraised value is below the amount the parties have agreed to. There are ways to remedy the situation.
The parties can renegotiate. If the seller is willing to lower the price so it’s in line with the appraisal, the deal can proceed. There will be less of a risk for the lender, so it will be more willing to approve a mortgage.
Another option is for the buyer to make a larger down payment to make up the difference between the house’s appraised value and the sale price. That may or may not be possible, depending on the buyer’s circumstances and the amount of the shortfall.
The buyer and seller may be able to work out a hybrid solution. The seller may be willing to reduce the price somewhat, but not enough to match the appraised value. The buyer can make up the difference with a larger down payment.
If the parties can’t work out an arrangement, the deal can fall through. Then the seller will have to search for a new buyer, and the buyer will have to continue house hunting.
Understand What You’re Signing
Discuss this and other types of contingencies with your real estate agent before you sign a contract.
