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Want to buy a house? You need to tread carefully. A real estate transaction is an expensive affair. And, it does involve a certain amount of risk. How? Well, once you’ve agreed to pay a sum for a house, and the seller accepts the offer, then both the buyer and seller are bound by a sales contract. If for any unforeseen reason you decide to walk away from the deal, you stand to lose your earnest money deposit. The only thing that can protect you and your money is an appraisal contingency. So, what is an appraisal contingency?
That’s exactly what we’ll learn in this blog. The idea behind an appraisal contingency is to let you, the home buyer, walk away from a deal with your deposit in case the house doesn’t appraise for the price you’ve agreed to pay. Let’s find out in detail what an appraisal contingency is, and how it protects a buyer’s interest.
What is an appraisal contingency?
An appraisal contingency is a clause or a condition in a real estate contract that allows a potential home buyer to back out of a financial deal if the property does not appraise at the purchase price. For instance, in case there’s a problem with the home financing or the condition of the property – appraisal contingency gives the buyer a way out.
When a buyer makes a purchase offer, the purchase contract should contain more information than just the sale price, details, and location of the property. It should also include conditions that must be met before a real estate contract becomes legally binding for both parties.
What does an appraisal contingency include?
A typical real estate contract would include three appraisal contingency stipulations:
- The house should be appraised at the sale price or higher. If the appraisal is lower, the sale price should be reduced to the appraised value. The goal is to help the buyer secure a house mortgage.
- The exact nature of the deal depends on the particular bank that grants a loan.
- The property in question should pass a home inspection, and mention the amount required in repairs, if any.
Only if these conditions are met within a specified time frame, the deal is accepted. If not, the buyer is entitled to a refund of their deposit.
How do appraisal contingencies work?
The mortgage lender typically hires a licensed appraiser to determine the value of the property based on its general condition, location, and comparable sales or comps in the neighborhood. This value determines if the deal is worth it or not.
Let’s take an example. Suppose you buy a house for $300,000 and pay a down payment of $30,000 while taking out a mortgage of $270,000. If the home appraisal value is $260,000, the bank will give you only that much loan amount. Since you’ll be $10,000 short, you may ask the seller to lower the sale price to make up the difference. If the seller refuses, you may break the deal and get your deposit back – thanks to the appraisal contingency.
Appraisal contingency vs finance contingency
Both finance contingency and appraisal contingency cover the same risks essentially. But, there’s a slight difference. If the property appraisal is less than your offer, there’s a possibility that the loan lender may agree to a smaller loan to meet the finance contingency. The seller may demand that the difference be paid by the buyer. In the absence of an appraisal contingency, if you don’t have the extra cash, you may be considered in breach of contract and may lose your earnest money deposit.
That’s why it’s important that an appraisal contingency be included in the sales contract. Therefore, it always pays to pay attention to the legal language of the contract.
Read more: Home sale contingency
How long is an appraisal good for?
As an appraisal is based on real-time valuation and comps, it may become outdated — depending on the local real estate market and its pace. It’s usually the lender who sets the time frame. The period typically ranges from 60 to 120 days.
Keep in mind that if there’s any delay in underwriting, the buyer may need to pay for a new valuation. However, different loan types, such as FHA loans, have their own requirements and timeframes.
When an appraisal is too low
If a deal fails to meet the appraisal contingency, both parties may be able to walk away. However, it’s in the interest of the buyer and seller to carry the deal through. If the property appraisal is too low, the buyer can petition the bank to reassess the value and ask for a second appraisal. They will have to give evidence of the house’s worthiness.
This could include solid evidence pointing to the fact that the appraiser may have missed relevant comps or valued features such as radiant-floor heating. The buyer may even be able to hire their own appraiser. In some cases, a third appraisal may also be granted, the cost of which will be borne by the buyer.
Should you waive the appraisal contingency?
No. Waiving for contingencies, even in a hot real estate market, is not a good idea. It will mean adding on the risk that you might not get the required home loan or your invested money back. The best option is to discuss the possibilities with your real estate agent or attorney. Waiving the contingency may make sense only when it’s very unlikely that the appraisal will be lower than the purchase price.
In most other situations, an appraisal contingency is an asset – especially for first-time homebuyers who may want to back out of a deal if things are not favorable.
If your offer for a house is higher than its appraised value, it could put you in a sticky situation. And, you may end up paying more out of pocket to close the deal. That’s why including an appraisal contingency in contracts is a wise decision.
An appraisal contingency gives both the parties the right to back out of their contract – but only under specific circumstances negotiated between the buyer and seller. It protects the interest of the buyer, ensuring that the property is valued at a specified minimum amount.