In a NutshellAn appraisal contingency clause is an important protection for homebuyers. If the appraisal is less than what you offered to pay for the home, this contingency lets you walk away without losing your earnest money.
An appraisal contingency clause is a safety net for potential homebuyers. It states that you plan to purchase the home, as long as certain conditions are met.
In particular, the terms of the contract depend on what happens during the appraisal process. An appraisal determines the fair market value of the home and can help ensure you don’t overpay for the property.
Occasionally, the appraised value may be lower than what you originally offered to pay for the home.
If you have an appraisal contingency clause, you’re generally free to walk away from the contract if the property doesn’t appraise for the amount you agreed to pay. This contingency typically ensures that you don’t lose out on your earnest money deposit. That said, it’s always a good idea to read the fine print just in case.
- What is an appraisal, and what is an appraisal contingency clause?
- What should you do if the property is appraised low?
- What is an appraisal contingency waiver?
- What are the consequences of using a contingency waiver?
What is an appraisal, and what is an appraisal contingency clause?
When you buy or refinance a home, your mortgage lender may require an appraisal. An appraisal is an analysis stating the fair market value of the home. Appraisers determine this value by looking at the property’s condition and considering similar homes and market trends in the area.
Most lenders require an appraisal to ensure they aren’t lending more than the home is actually worth. The appraisal ensures that the property is sufficient collateral for the mortgage. An appraisal also lets the borrowers know if they might be overpaying for the home if they close the deal.
If the appraisal comes back lower than what you agreed to pay for the home, you can ask the seller to renegotiate the price. But your request may have more leverage if you have an appraisal contingency in place.
An appraisal contingency clause typically states that if the appraisal value is lower than what you agreed to pay for the home, you can walk away from the contract. And most importantly, you’ll have your earnest deposit refunded if you and the seller can’t come to an agreement.
Earnest money is an escrow deposit often made after your home offer is accepted. And while the exact amount varies depending on your situation, it’s usually between 1% and 5% of the total home purchase price. That means on a $200,000 home, you can expect to put down between $2,000 and $10,000 in earnest money.
Appraisal contingency vs. financing contingency
In addition to an appraisal contingency, your real estate agent may recommend a financing contingency.
A financing contingency protects homebuyers if they’re unable to get approved for a mortgage. It usually states that if you put forth a reasonable effort to apply for financing but are unable to get approved, you won’t lose out on your earnest deposit.
A financing contingency should protect you as a homebuyer, but borrowers will occasionally forgo this option in a seller’s market. When there are multiple offers on the same house, excluding any contingencies might make your offer more competitive.
That’s because contingencies can represent more risk to sellers, so they prefer offers without them. But doing this can expose you to potential financial risk, and you could lose out on your earnest money if you’re unable to secure financing.
What should you do if the property is appraised low?
If the appraisal report shows that your potential home is worth less than what you agreed to pay for it, this may complicate your financing. In general, you have the following choices:
- You can agree to pay the difference in cash (depending on the type of loan financing, the difference may not be an option).
- You can decide to simply walk away from the deal, albeit with potential consequences.
- You can try negotiating with the seller to lower the purchase price of the home. If the seller is unwilling to lower the price and you have an appraisal contingency, you can then walk away from the home sale.
What is an appraisal contingency waiver?
If you’re really committed to a home or it’s a competitive market, you may include an appraisal contingency waiver in your offer. That means you agree to pay the full amount of the sale contract, even if the appraisal value comes in low.
In June 2020, just over 20% of winning home offers waived the appraisal contingency, according to Redfin. In some situations, an appraisal contingency waiver could make sense. For example, in a bidding war, waiving the appraisal contingency could help you emerge as the successful offer.
What are the consequences of using a contingency waiver?
If you waive the appraisal contingency and the home is appraised low, you may have less room to negotiate with the seller on the home price. If you choose to walk away from the sale altogether, you may lose out on your earnest money. Depending on the sale price, this could end up being thousands of dollars.
As a homebuyer, the appraisal contingency clause is an important safety net for you — it gives you more options if your appraisal value comes in low. If there’s a problem with the appraisal, start by trying to work with the seller.
See if the seller is willing to meet you in the middle on the offer price. But you should always consult with your real estate agent to find out what your other options might be.