Appraisal contingency: What is it and why you might need one
Buying a home is generally a serious commitment. There’s often a significant amount of money on the line, and many homeowners need a mortgage to afford the purchase. As part of the mortgage process, lenders usually require a property appraisal to ensure they’re not financing more than a home is worth. As a homebuyer, you may want the same reassurance, as homes are sometimes priced higher than their actual appraised value. When this happens, it may make it harder to get a mortgage approved.
Fortunately, there’s a way for homebuyers to back out of a purchase if an appraisal reveals that the home was mispriced: the appraisal contingency. Whether you’re buying or selling, it may be worthwhile to explore this type of contingent offer, how it works and the scenarios in which it could be useful.
What is an appraisal contingency?
If you agree to purchase a home at a certain price and it’s revealed through appraisal it’s worth less, you could be stuck in a bit of a bind. An appraisal contingency essentially protects you from paying more than a property is worth, losing your deposit or potentially having to make up the difference out of your own pocket if there’s an appraisal gap. It's a clause that makes the sale of the property contingent on its appraised value being equal to or greater than a specified amount. If a home appraisal reveals that a property’s owner has misrepresented its value, then you as the prospective buyer are permitted to walk away with your deposit or renegotiate if you’re still interested.
How do appraisal contingencies work?
After you and the seller have agreed on a purchase price and you’re in the process of securing a mortgage, the lender will hire a professional to assess the property. This licensed professional will examine its living condition and any apparent permanent home improvements and weigh these findings against home values in the area to come up with an informed valuation. If the number is lower than the purchase price, you may want to ask the seller to make repairs or improvements that cover the difference or lower the price to the appraised value. You also have the option to walk away from the purchase altogether. Most appraisal contingency clauses include a date upon which you must inform the seller of any discrepancy, so it’s imperative for you to keep this in mind. If you for some reason inform the seller after the agreed-upon date, you may lose the ability to walk away from the purchase with your deposit intact.
Appraisal contingency example
Let’s say you’re buying a home with a purchase price of $350,000 and you're putting a down payment of $40,000. This means you’re looking to get a mortgage for the remaining $310,000. If the home is appraised for $290,000, however, the lender will only approve a mortgage up to that appraised value. If you’re not willing to pony up the difference and you have an appraisal contingency, you have the option of backing out of the sale, usually with your deposit, or renegotiating with the seller to find ways to close the gap.
Other types of contingencies
As you can see, appraisal contingencies are designed to protect buyers from making a purchase they may end up regretting due to an appraisal gap. Appraisal contingencies aren’t the only clauses designed to protect buyers. Contingency clauses typically act as exit points that allow either the buyer (or in certain cases, the seller) to back out of the deal without penalty if certain conditions are not met. Some of the other most common contingencies in real estate include:
- Financing contingency: As a home tends to be a significant purchase, many buyers need a mortgage to help them pay for the property. Financing contingencies give the buyer a way out of the deal if they're unable to secure a favorable mortgage, with no penalty for backing out. This type of contingency protects the buyer from potentially getting stuck with a house they can't actually afford.
- Title contingency: A house title refers to the legal ownership of a property, and title contingencies essentially mean that a purchase will only go through if the seller can prove they have rightful legal ownership of the property in question and are able to transfer ownership to the buyer without any issues.
- Inspection contingency: These contingencies are also known as “due diligence contingencies,” allowing the buyer to have the home inspected within a certain window of time. Depending on the results, the buyer may negotiate to have repairs done, have the purchase price reduced or walk away from the deal should the issues end up being extensive.
Waiving appraisal contingency
While appraisal contingencies do protect buyers, there are scenarios where the option to waive the appraisal contingency may be attractive. For example, if the home you’re looking for is in high demand and the seller wants to close quickly, waiving the contingency may show them that you’re serious enough to let go of some leverage. This move is safest when there’s a low chance of the appraisal being much lower than the selling price.
Additionally, if you’re paying cash and don’t need to work with a lender, you may not be as concerned about an appraisal gap, or maybe even an appraisal in general (though it’s generally still best practice to ensure an accurate valuation). While waiving an appraisal contingency may make sense in these situations, including it is generally helpful for the majority of buyers, especially if they’re less experienced with the housing market.
If you’re buying a home and it’s appraised for less than the selling price, you may feel frustrated but you’re not out of options — an appraisal contingency might have your back. These clauses are designed to protect you from getting stuck with an overpriced home or insufficient mortgage. While appraisal contingencies may not be necessary for every property purchase, a solid understanding of appraisal contingencies may help you make informed decisions down the homebuying or selling road.
Appraisal contingency FAQs
1. Do you need an appraisal contingency?
While a majority of homebuyers may benefit from an appraisal contingency, there are some situations where it could make sense to skip the process. For example, if you want to move quickly on a popular home or are paying cash. An appraisal contingency is more of an electable protection — nice to have, but not an actual necessity.
2. How do you write an appraisal contingency?
As appraisal contingencies are legal documents, it’s best to consult with local real estate professionals or lawyers to learn how to write an appraisal contingency. They may provide you with sample documents and templates or potentially even sit down and help you draft it themselves. The latter will likely require hiring them professionally, but the former may fall under the scope of a general consultation.
3. How long does an appraisal contingency take?
Depending on your situation, the appraisal contingency process could take anywhere from a couple of weeks to a month or so. Sometimes lenders will expedite the process, but you’ll have to consult with your lender or real estate agent to get a more accurate timeline based on your situation.
4. Should I waive appraisal contingency?
Whether you should waive the appraisal contingency or not hinges on your buying situation. If you’re confident that the home will not be appraised for much less than the selling price, are trying to move quickly or have quite a bit of cash handy, it may be worth considering.