As a home buyer it is normal to want to pay fair market value or less for the property that you are considering. If you are obtaining a mortgage to purchase the home, your lender will certainly feel the same way. After all, lenders do not want to loan more money than an asset is worth. One tactic that can be utilized to avoid appraisal problems is the appraisal contingency. An appraisal contingency is a separate addendum that can be added to the sales contract that is essentially an agreement between the seller and the buyer that allows for a third party appraisal to be performed on the property.
How it works
An appraisal contingency can be used whether you are a cash buyer or a buyer obtaining a mortgage. If you are a cash buyer wanting to utilize an appraisal contingency, you will certainly want to have a written contingency drafted and included with the contract. If you are a buyer obtaining a mortgage, you will have an implied contingency. In other words, it is assumed that your lender will order an appraisal prior to agreeing to a loan commitment. With this said, it is possible that a lender ordered appraisal comes in lower than the sales price. In this case, the lender may not agree to a loan commitment or may offer to finance a lower amount. It is important for buyers to note that if a lower amount to finance is offered by the lender, the buyer may not be able to escape the contract. In this case, the seller may demand that the buyer pay the difference in the amount of the sales contract and the appraisal. If the buyer is unable to do so, they could risk losing their earnest money deposit. Therefore, a best practice as a buyer (cash or mortgage) is to obtain a written appraisal contingency if you have a concerns about the property appraising for the sales amount.
Summary
It is no secret that the past few years have been seller’s markets. Typically in seller’s markets, we do not see appraisal contingencies utilized nearly as often. With many homes receiving multiple offers above asking price, an appraisal contingency is viewed unfavorably by sellers. On the flip side, we tend to see appraisal contingencies more often during buyer’s market. With home price reductions currently at 7 year highs or so, we can expect appraisal contingencies to be more common in the foreseeable future.
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