What is An Appraisal Contingency and How Can it Impact Your Homebuying Journey?

Are you a first-time homebuyer? Or are you a seasoned buyer looking to upgrade or downsize your living space? Regardless of your experience, navigating the housing market can be daunting, especially when it comes to understanding the complex jargon and legalities involved in purchasing a property. One important concept that all homebuyers should be familiar with though is the appraisal contingency. In this guide, we will explore what an appraisal contingency is and how it can impact your homebuying journey.

What is an appraisal contingency?

An appraisal contingency is a clause in a real estate contract that allows the homebuyer to back out of the transaction or renegotiate the terms of the sale if the property appraisal comes in lower than the agreed-upon purchase price.

When a buyer applies for a mortgage to purchase a home, the lender requires an appraisal of the property to determine its fair market value. If the appraisal comes in lower than the agreed-upon purchase price, the buyer may not be able to obtain financing for the full amount, and may have to pay the difference out of pocket or renegotiate the terms of the sale.

With an appraisal contingency in place, the buyer can protect themselves from being obligated to pay more than the fair market value of the property. If the appraisal comes in lower than the purchase price, the buyer has the option to back out of the sale without penalty or renegotiate the terms of the sale to reflect the appraised value.

What is a contingent offer?

A contingent offer is a type of offer made by a buyer to purchase a property that is contingent upon certain conditions being met. These conditions typically relate to the sale of the buyer’s current property, securing financing, passing a home inspection, or the home being appraised reflects fair market value.

For example, a buyer might make a contingent offer on a property they want to purchase, but the offer is contingent upon the sale of their current home. If their home sells within a specified period, the contingent offer becomes a firm offer and the sale proceeds as planned.

How does an appraisal contingency work?

An appraisal contingency states that the sale of the property is contingent upon the property being appraised for a certain value. Here’s how it works:

1. The buyer and seller agree on a purchase price for the property.
2. The buyer has a professional appraiser evaluate the property to determine its value. The appraiser considers factors such as the property’s size, location, condition, and recent comparable sales in the area.
3. If the appraised value of the property is equal to or higher than the purchase price agreed upon by the buyer and seller, then the contingency is satisfied, and the sale can proceed as planned.
4. If the appraised value of the property is lower than the agreed-upon purchase price, then the buyer has several options, such as:
   • Negotiate with the seller to lower the purchase price to match the appraised value.
   • Request that the seller make repairs or upgrades to the property to increase its value.
   • Walk away from the sale altogether, as the contingency allows them to do so without penalty.

An appraisal contingency is important because it protects the buyer from overpaying for a property that is not worth the purchase price. It also provides a way for the buyer to renegotiate or back out of the sale if the property is appraised at a lower value than expected.

Difference between the appraisal contingency and a finance contingency 

An appraisal contingency and a finance contingency are two common types of contingencies included in a real estate purchase agreement. Here are the key differences between them:

• Definition: An appraisal contingency is a clause in a real estate purchase agreement that makes the sale of the property contingent upon the property’s appraised value meeting or exceeding a certain amount. A finance contingency, on the other hand, is a clause in a real estate purchase agreement that makes the sale of the property contingent upon the buyer obtaining financing to purchase the property.
• Purpose: The purpose of an appraisal contingency is to protect the buyer from overpaying for the property. Whereas, the purpose of a finance contingency is to protect the buyer from being contractually obligated to purchase the property if they are unable to secure financing. 
• Timing: An appraisal contingency is typically included in the initial purchase agreement and is usually resolved during the inspection period. A finance contingency is also typically included in the initial purchase agreement and is resolved once the buyer has secured financing, which may take several weeks.

What happens when the house appraises for less than your offer?

If the house appraises for less than the offer, it means that the appraised value of the property is less than the agreed purchase price. This situation can have several consequences, including:

• Renegotiation of the purchase price: If the house appraises for less than the offer, the buyer can negotiate with the seller to reduce the purchase price to match the appraised value. If the seller agrees to reduce the price, the buyer can proceed with the purchase.
• Additional down payment: If the buyer still wants to purchase the property at the agreed price, even though the appraisal value is less, the buyer may need to make a larger down payment to compensate for the shortfall in the appraised value. This is because the lender will only provide a mortgage loan up to the appraised value of the property.
• Cancelation of the deal: If the seller is not willing to renegotiate the purchase price, and the buyer is unable or unwilling to make a larger down payment, the deal may be canceled. This can be frustrating for both parties, as it means that the transaction cannot proceed as planned.

It’s important to note that a low appraisal is not always a deal breaker. If the buyer and seller are willing to work together to find a mutually acceptable solution, they may still be able to proceed with the purchase.

Appraisal contingency example

Here’s an example of how an appraisal contingency might be used in a real estate transaction:

Bob is interested in buying a house in Las Vegas that is listed for $400,000. He makes an offer of $400,000, and the seller accepts his offer. However, before the sale can go through, the property must be appraised to ensure that the purchase price is fair and reasonable.

If the appraisal comes back and values the property at $380,000, Bob has the option to either:

1. Walk away from the deal and receive his earnest money deposit back.
2. Negotiate with the seller to lower the purchase price to match the appraised value.
3. Agree to pay the original purchase price even though the property was appraised for less.

In this scenario, Bob has the protection of an appraisal contingency, which allows him to back out of the deal or renegotiate the price if the property doesn’t appraise for the agreed-upon amount.

What is an appraisal gap clause?

An appraisal gap clause is a provision in a real estate contract that addresses the difference between the appraised value of the property and the purchase price agreed upon by the buyer and seller.

When a buyer obtains financing to purchase a property, the lender will also require an appraisal to ensure that the property is worth the amount of the loan. In a competitive real estate market, a buyer may offer to pay more than the appraised value of the property in order to secure the purchase. In this case, an appraisal gap clause can be included in the contract to address the potential difference between the purchase price and the appraised value.

The clause may state that if the appraised value comes in lower than the purchase price, the buyer will be responsible for paying the difference out of pocket, up to a certain amount. Alternatively, the clause may allow the buyer to back out of the contract or renegotiate the purchase price if the appraised value is significantly lower than the agreed-upon price.

An appraisal gap clause is designed to protect both the buyer and the seller by providing a clear understanding of how to proceed if the appraised value differs from the purchase price.

When should I use or waive an appraisal contingency?

Here are some factors to consider when deciding whether to use or waive an appraisal contingency:

Use an appraisal contingency when:

1. You are obtaining financing: If you are obtaining financing to purchase the property, the lender will typically require an appraisal to determine the value of the property. 
2. The property is unique: If the property is unique and there aren’t many comparable properties to use for the appraisal, it may be wise to include an appraisal contingency to protect yourself in case the appraiser values the property lower than the purchase price.
3. You are concerned about overpaying: If you are concerned that you may be overpaying for the property, including an appraisal contingency can give you an out if the property doesn’t appraise for the purchase price.

Waive an appraisal contingency when:

1. You are a cash buyer: If you are a cash buyer and don’t need financing to purchase the property, you may consider waiving the appraisal contingency. In this case, you would be assuming the risk that the property won’t appraise for the purchase price, but if you are comfortable with that risk, waiving the contingency can make your offer more attractive to the seller.
2. The property is in high demand: If the property is in a highly competitive market and there are multiple offers, waiving the appraisal contingency can make your offer more competitive. However, be aware that if the property doesn’t appraise for the purchase price, you may be responsible for making up the difference in cash.
3. You are confident in the value: If you have done your own research and are confident that the property is worth the purchase price, you may consider waiving the appraisal contingency. However, be aware that if the property doesn’t appraise for the purchase price, you may again be responsible for making up the difference in cash.

What determines the appraisal value of a home?

The appraisal value of a home is determined by a licensed appraiser who evaluates various factors such as:

1. Property characteristics: The appraiser considers the square footage of the property, the number of bedrooms and bathrooms, the age of the property, and any unique features such as a pool or fireplace.
2. Location: The appraiser looks at the location of the property, including the neighborhood, nearby amenities, and school district.
3. Comparable properties: The appraiser compares the property to recently sold properties in the area that are similar in size, age, and features to determine a fair market value.
4. Condition of the property: The appraiser evaluates the condition of the property, including any needed repairs or updates.
5. Market trends: The appraiser considers market trends and economic conditions that may affect the value of the property.
6. Zoning and use restrictions: The appraiser takes into account any zoning or use restrictions that may affect the value of the property.

All of these factors are taken into consideration by the appraiser to determine the fair market value of the property. The appraisal value is important in determining the maximum amount a lender is willing to finance and helps the buyer and seller negotiate a fair price for the property.

What are other types of real estate contingencies?

There are several other types of real estate contingencies that buyers may include in their purchase contracts to protect themselves. Here are some common types of contingencies:

1. Financing contingency: This contingency allows the buyer to back out of the transaction if they are unable to secure financing to purchase the property.
2. Inspection contingency: This contingency allows the buyer to have a professional home inspection conducted to identify any issues with the property. If significant issues are found, the buyer can negotiate repairs or back out of the transaction.
3. Title contingency: This contingency allows the buyer to back out of the transaction if there are issues with the property’s title, such as liens or disputes over ownership. 
4. Home sale contingency: This contingency is used when the buyer needs to sell their current home before purchasing the new property. If the buyer is unable to sell their home, they can back out of the transaction.

Including these contingencies in the purchase contract can give the buyer more protection and flexibility during the transaction. However, it’s important to note that including too many contingencies can make the offer less attractive to the seller, so buyers should consider which contingencies are most important to them.

FAQs about appraisal contingencies

Is there an appraisal contingency deadline?

The appraisal contingency deadline is negotiated between the buyer and seller and is typically set at 7 to 10 days after the appraisal is conducted. If the buyer misses the deadline, they may lose their right to terminate the contract based on the appraisal results. It’s important to understand and meet all the deadlines in the contract with the help of a real estate agent or attorney.

How long is an appraisal good for?

Appraisals are typically considered valid for 120 days (4 months) from the date of the report, but the validity period can vary depending on the type of loan and the lender’s requirements. Government-backed loans may have a longer validity period of up to 180 days (6 months). However, market conditions and other factors can affect the value of the property over time, so the appraisal is only a snapshot of the property’s value at a specific point in time.

Can a seller back out if the appraisal is high?

It’s rare for a seller to back out of a transaction because the appraisal value is high. Generally, once the purchase agreement is signed, the seller is legally bound to sell the property to the buyer at the agreed-upon price, regardless of the appraisal value. However, there may be some exceptions depending on the terms of the contract and state laws. Buyers and sellers should review the purchase agreement carefully and consult with a real estate agent or attorney if they have concerns.

Who pays for an appraisal?

In a typical home purchase transaction, the buyer is responsible for paying for the appraisal as part of their closing costs. However, in some cases, the seller may agree to pay for the appraisal. 

How long does an appraisal take?

The timeframe for an appraisal can vary depending on factors such as the size and complexity of the property, the appraiser’s workload, and local market conditions. Generally, the appraisal process can take anywhere from a few days to a few weeks.

How much does an appraisal cost?

The cost of an appraisal varies depending on the location, size, and complexity of the property, but it typically ranges from a few hundred dollars to several hundred dollars.

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