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Buying a home is risky. You sign a contract and place a bid which makes you legally bound to buy the property. If all the pieces fall in place, you’re in a good position. But what if they don’t?
What if the home appraisal isn’t high enough?
You may want to include an appraisal contingency. Here’s everything you must know.
What Is an Appraisal Contingency?
An appraisal contingency protects buyers from paying too much for a home. If you have an appraisal contingency and the house doesn’t appraise for at least as much as you agreed to pay, you can back out of the contract.
Why is the contingency important?
Normally, without a contingency, you lose your earnest deposit or the money you put down when you bid on the home if you back out of a contract.
During the escrow process, a neutral third party holds onto the funds – usually the title company.
When something occurs, whether you close on the sale, back out with a contingency, or back out without it, the escrow agent determines who keeps the earnest money.
The appraisal contingency protects you if you need to back out because the home isn’t worth as much as you offered.
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How Do Appraisal Contingencies Work?
When you negotiate the sales price and terms of the sale, you’ll negotiate contingencies, including the appraisal contingency.
What you’re telling the seller is that you agree to buy the home if the appraiser agrees the home is worth at least as much as you offered.
If the seller accepts your terms, including the appraisal contingency, you have until a specific date; usually, a couple of weeks, to have the appraisal completed and to determine if you’re buying the house.
If the appraisal comes in lower than the amount you offered, you can back out of the sale without losing your earnest deposit.
If you don’t want to back out of the sale, you have a couple of other options:
- Re-negotiate the sales price with a price comparable to its fair market value according to the appraiser
- Pay the difference between the appraised value and the agreed-upon sales price in cash
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Appraisal Contingency Example
Ken put an offer in of $300,000 on a home. He bid the full asking price because he really wanted the home and knew there was a lot of interest in it.
In his contract, Ken negotiated an appraisal contingency. The seller agreed, and Ken put down $10,000 in earnest money.
The appraiser did his inspection and report right away, getting it back to Ken in one week from the date they signed the contract.
The appraiser stated that the fair market value of the home is $290,000, not $300,000. Ken decides he doesn’t want to invest $10,000 more in a home than it’s worth (which is smart) and walked away from the sale. Ken got to keep his earnest money deposit too.
How Does an Appraisal Contingency Protect You?
An appraisal contingency protects you from paying too much for a home. Without the contingency, you could be stuck in a contract to pay much more for a home than it’s worth.
This could cause financial devastation and put you into an investment upside down (owing more than it’s worth).
When Do You Need an Appraisal Contingency?
Honestly, everyone should use an appraisal contingency when applying for a mortgage and buying a house. Unless you’re an expert and know the price you agreed to pay is within the market value, protect yourself.
Certain people should never consider going without an appraisal contingency, though. This includes:
- First-time homebuyers – Buying a home for the first time is overwhelming and expensive. Protecting yourself as much as possible is important.
- Buyers with a limited budget – If you bid near your spending limit, you don’t have wiggle room to make up the difference if the appraised value comes back slightly lower than your offer. Without the contingency, you’d be stuck in a contract and at risk of losing your earnest money.
What Happens if the Appraisal is Lower than the Offer?
A low appraisal is a bummer, and it often leads to a canceled sale. But in certain cases, it doesn’t:
- If you can make up the difference between the sales price and the appraised value, you can add it to your down payment and still buy the house
- If the seller will negotiate a lower sales price under the appraised value
When Should You Waive an Appraisal Contingency?
An appraisal contingency is almost always a good idea, but you may want to waive it in certain cases:
- It’s a seller’s market, and sellers can have their pick of any buyer they want. They’ll typically pick the buyer without any contingencies.
- If you’re paying cash for the home. Since there’s no lender, you don’t need an appraisal unless you want one for your own knowledge.
Mortgage Contingency vs. Appraisal Contingency: What Are the Differences?
A mortgage contingency is another layer of protection should you want to or need to back out of a contract.
The mortgage contingency protects you if the online mortgage lender doesn’t approve your loan. It has some relationship to the appraisal contingency, though. If the home doesn’t appraise high enough, the lender won’t approve your loan.
You can usually get by with one or the other, but if you’re worried about your chances of securing financing, you may want to choose the mortgage contingency over the appraisal contingency.
Why Are Appraisal Contingencies Important?
The appraisal contingency is one of the most important contingencies. Without it, you could be on the hook to buy a house even if it’s worth less than the appraised value.
This means you could buy a home, paying more than it’s worth. It could take a long time to earn the money back and have any equity in the house.
Frequently Asked Questions
How Long Does an Appraisal Contingency Take?
Every seller is different, but most allow at least 2 weeks for an appraisal contingency. This should give the appraiser enough time to come out, look at the home, and write up the report.
It should also give you enough time to review the appraisal report and decide if you still want to buy the home.
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What Is an Appraisal Contingency Waiver?
An appraisal contingency waiver isn’t common and sometimes isn’t smart. Unless you know you can pay the price you offered on the home regardless of its value and how much loan you can get, consider including the appraisal contingency in your contract.
What Is an Appraisal Contingency Addendum?
An appraisal contingency addendum lets lenders know that you will buy the home even if the appraised value comes in lower than the sales price.
It tells lenders you will put down more than required on the home to ensure you can buy it no matter its value.
How Does Appraisal Contingency Removal Work?
If you decide you no longer ant the appraisal contingency, you can ask your real estate agent to complete an appraisal contingency removal form. After you sign it, the form must go to the sellers for their signature too.
Are Appraisal Contingencies Smart for Home Buyers?
Appraisal contingencies are one of the smartest levels of protection you can put on a sales contract. It protects your investment in the home if the appraised value isn’t as high as you thought it would be.
Bottom Line: What Is an Appraisal Contingency?
Discuss your need for an appraisal contingency with your lawyer or financial advisor before signing a contract.
Even your real estate agent can help. Get a professional opinion about the home’s value and if the sales price you agreed to is within reason or if you should protect your investment with a contingency.