DO I NEED AN APPRAISAL CONTINGENCY?
An appraisal contingency allows buyers to void the contract or negotiate the sales price if the appraised value is lower than the ratified sales price.
An appraisal contingency can be part of a cash purchase or a conventional loan. With a VA or FHA loan, the appraisal contingency is automatically built-in to the financing contingency. With a conventional loan, it is a separate contingency.
No matter which loan program you choose, the lender will require an appraisal as part of the loan in order to approve it. Lenders want to make sure that the house is actually worth what you’re paying for it since they are loaning the money to you to pay for it.
As a buyer this is an important contingency if you can include it because it protects you from overpaying for a house. However, if you have a conventional loan, you can choose not to include it to make your offer stronger. Some lenders also have creative ways to remove it to be more competitive if you are using a VA or FHA loan. Why would you remove the contingency when making an offer? For several reasons. 1) You feel confident the home will appraise now. 2) You plan to be in the home and you anticipate the home will grow in value. 3) You have the cash to make up any difference. 4) There are other offers on a home, and you want to bring the best offer.
THE APPRAISAL CONTINGENCY
First you must determine if you will A) make the contract contingent on the appraisal and B) if you would like to add an appraisal contingency gap guaranty. In a competitive market, you may decide to forgo the appraisal contingency, however if the house does not appraise at the sales price value, you will be responsible for making up the difference.
- If you choose to make the contract contingent on the appraisal, you should discuss with your lender the number of days it will take to get the appraisal which will be written into the contract (the quicker the better in the eyes of the seller). Then if the appraisal comes in under the sales price, you’ll be able to negotiate the sales price within a decided upon negotiation period, or you can void the contract within a decided upon election period if an agreement is not reached.
- If you choose an appraisal contingency plus the gap guaranty, you agree as the buyer to pay the difference between the appraisal and the sales price up to a certain predetermined amount. The same negotiation and election periods apply.
HOW DOES THE APPRAISAL CONTINGENCY WORK IN PRACTICE?
The lender will order an appraiser to go to the property in person, measure, note the amenities, and put a value on it based on comparable sales in the past six months. If the value is equal to or above the sales price, the property has “appraised” and the contingency can be removed. If the value is lower than the sales price, the lender will not make the loan as it is currently structured. Lenders will only loan up to the appraised value. Thus, the buyer and seller have three options.
- The buyer could decide to bring the difference between the appraised value and the sales price in cash to be added to their down payment.
- Alternatively, the seller could lower the sales price to the appraised value.
- Most often, the buyer and seller negotiate this somewhere in the middle so that the sales price is lowered and the buyer brings additional cash to the table. Both parties moving towards the middle make the negotiations more palatable.
If none of those options is acceptable to the parties, the buyer can void the contract. If the buyers feel that the valuation was faulty, they can also decide to challenge the appraisal or use a new lender and get a new appraisal.
HOW LONG IS A NORMAL APPRAISAL CONTINGENCY?
Typically we recommend you ask your lender how long it will take to get an appraisal (~10-14 days) – as mentioned above, for FHA and VA loans, automatically build this contingency into the financing contingency. The timeline can be shorter if your lender is able to do a rush order.
WHY MIGHT A PROPERTY NOT APPRAISE?
If there have not been sales in the defined neighborhood in the past six months or if the sold homes have been smaller or in poor condition, the value might not appraise. In a market where values are going up (which often happens in spring markets), the value may not be as high as the market conditions are dictating. Be sure to discuss all of these factors with your agent when an appraisal comes in below the contract price.
THE BOTTOM LINE
The appraisal contingency is one of our favorites because it can protect you from overpaying for a house. However, removing it from a contract can also be a good way to strengthen your offer if you know you have the extra cash on hand in the event the appraisal comes in low.
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