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Appraisal Contingency: What Is It and How Does It Work?

Understand how an appraisal contingency works in real estate transactions, its importance, and the risks and benefits of waiving it.

Appraisal Contingency: What Is It and How Does It Work?

An appraisal contingency is a clause in a real estate purchase agreement that allows the buyer to back out of the deal if the property's appraised value is less than the agreed purchase price. This safeguard ensures buyers do not overpay for a property and gives them leverage to negotiate or exit the contract if the appraisal comes in low.

How Does an Appraisal Contingency Work?

An appraisal contingency provides a specific period during which the property must be appraised by a licensed professional. If the appraisal is lower than the purchase price, this contingency offers several options to the buyer. 

First, the buyer can renegotiate the purchase price, asking the seller to lower it to match the appraised value. If the seller agrees, the sale can proceed at the new, lower price. Alternatively, the buyer may choose to pay the difference out of pocket, covering the gap between the appraised value and the purchase price to maintain the original agreement. 

If neither option is viable, the buyer has the right to walk away from the deal without losing their earnest money deposit. This safeguard ensures that buyers do not overpay for a property, providing financial protection and flexibility in the transaction.

Why Include an Appraisal Contingency?

Including an appraisal contingency in your real estate contract is essential for protecting buyers from overpaying for a property. This contingency ensures that the buyer is not obligated to proceed with the purchase if the property's appraised value is lower than the agreed-upon price. 

Since lenders typically do not finance amounts exceeding the property's appraised value, this clause safeguards the buyer from having to cover a potentially significant price gap out of pocket.

Additionally, the appraisal contingency provides buyers with leverage to renegotiate the purchase price based on the appraised value, ensuring they are paying a fair market price. If the appraisal comes in low, the buyer can request that the seller lower the price accordingly.

Learn more:
How Long Does an Appraisal Take? Explained Step by Step

Example of an Appraisal Contingency

An appraisal contingency clause might look like this:

"Buyer’s obligation to purchase the property is contingent upon the property appraising for no less than the purchase price. If the appraisal is lower, Buyer may terminate this Agreement by providing written notice to Seller within [specified number of days], and Buyer’s earnest money deposit shall be returned in full."

Appraisal Contingency vs. Financing Contingency

When buying a home, it's important to understand the roles and differences between an appraisal contingency and a financing contingency, as both offer critical protections but in different ways.

Appraisal Contingency:

As stated before, an appraisal contingency specifically protects the buyer from overpaying for the property. This clause allows the buyer to renegotiate the purchase price or exit the deal if the appraisal comes in lower than the agreed-upon price.

Essentially, it ensures that the buyer is not obligated to pay more than the property's fair market value, which is crucial in avoiding financial overcommitment. 

If the appraisal reveals a lower value than the purchase price, the buyer can ask the seller to lower the price to the appraised value. If the seller refuses, the buyer has the option to pay the difference out of pocket or walk away from the deal without losing their earnest money deposit.

This protection is particularly valuable in fluctuating markets where property values can vary widely and unexpectedly.

Financing Contingency

A financing contingency, on the other hand, protects the buyer if they are unable to secure financing for the purchase. This contingency typically includes specific terms related to the buyer’s loan approval, such as the interest rate, loan type, and approval timeline.

If the buyer is unable to obtain the necessary financing within the specified period, this contingency allows them to cancel the contract without penalty. This is crucial as it ensures the buyer is not forced to proceed with the purchase if they do not have the financial backing.

The financing contingency acts as a safety net, ensuring that buyers are not legally bound to buy a property without a secured loan, which could otherwise lead to significant financial distress.

Both contingencies are essential in protecting buyers, ensuring they are not compelled to complete a purchase if certain conditions are unmet.

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Should You Waive the Appraisal Contingency?

Waiving the appraisal contingency means that you, as the buyer, are agreeing to proceed with the purchase of the property regardless of its appraised value. Normally, an appraisal contingency protects you by allowing you to renegotiate the purchase price or even withdraw your offer without losing your earnest money if the appraisal comes in lower than the purchase price.

By waiving this protection, you commit to covering any shortfall between the appraised value and the purchase price out of your own pocket, which can be a significant financial risk.

Deciding whether to waive this contingency involves weighing the potential benefits against the associated risks. Here’s a closer look at the pros and cons of doing so:

Pros of Waiving the Appraisal Contingency

Stronger Offer:

In competitive markets where multiple offers are common, waiving the appraisal contingency can make your offer stand out. Sellers are often looking for the least complicated deal, and an offer without an appraisal contingency suggests fewer potential obstacles to closing. According to a survey by the National Association of Realtors, 20% of home buyers waived their appraisal contingency in 2020 to strengthen their offers.

Faster Closing:

Waiving the appraisal contingency can expedite the closing process. Without waiting for the appraisal results, the timeline from offer acceptance to closing can be significantly reduced. This can be particularly appealing to sellers who need to sell quickly or have already purchased another property.

Cons of Waiving the Appraisal Contingency

Financial Risk:

One of the most significant risks of waiving the appraisal contingency is the potential financial burden. If the property's appraised value comes in lower than the purchase price, the buyer must cover the difference out of pocket. For instance, if you agree to buy a home for $300,000, but the appraisal is only $280,000, you’ll need to come up with the $20,000 shortfall in addition to your down payment and other closing costs.

Limited Negotiation Power:

Without the appraisal contingency, you lose a critical negotiating tool. Typically, if the appraisal is low, the buyer can renegotiate the purchase price or ask the seller to make concessions. Waiving this contingency removes that leverage, potentially leaving you stuck with a higher-than-expected price.

Risks of Waiving the Appraisal Contingency

Waiving the appraisal contingency can be risky because it exposes the buyer to potential financial pitfalls. If the property appraises lower than the purchase price, the buyer must cover the difference out of pocket, which can significantly impact their finances.

Why Would a Seller Want to Remove an Appraisal Contingency?

Sellers might prefer offers without an appraisal contingency because it reduces the risk of the deal falling through due to appraisal issues. This is especially attractive in a hot market where multiple offers are common.

How to Handle a Low Appraisal

If the appraisal comes in low, buyers have several options:

Renegotiate the Price: Try to convince the seller to lower the price to match the appraised value.
Challenge the Appraisal: Provide evidence to the appraiser to support a higher valuation.
Pay the Difference: Pay the difference between the appraised value and the purchase price out of pocket.
Walk Away: Exercise the appraisal contingency to cancel the contract and get your earnest money back.

The Bottom Line

An appraisal contingency is a vital component of a real estate transaction that safeguards the buyer from overpaying for a property. While waiving it can make an offer more competitive, it also increases financial risk. Understanding the implications and navigating the process effectively can help buyers make informed decisions and protect their investments. For more detailed advice tailored to your specific situation, it's recommended to consult with a real estate professional or legal advisor.

Marcio Vasconcelos

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Marcio Vasconcelos

Marcio Vasconcelos is the CEO, Realtor, Marketing Specialist and founder of the Home Shift Team. With a revolutionary approach to real estate, Marcio has been shaking things up in Massachusetts with his BullsEye Marketing Strategy. He has been delivering exceptional results for his clients through strategic marketing, helping them to...

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