What is the Appraisal Contingency in NYC
Go Back To Previous PageAn appraisal contingency is often included in real estate purchase agreements to protect the buyer. The buyer can withdraw from the contract if the property is appraised for less than the
agreed-upon purchase price. This clause ensures that the buyer is not required to pay more than the property’s market value.
What Is an Appraisal Contingency?
An appraisal contingency is a clause in a purchase contract stating that the buyer’s offer depends on the appraisal results. If the home’s appraisal comes in lower than expected, the buyer can back out of the purchase.
While you can work with a broker to get a rough estimate of a property’s value using comparable properties (comps), it’s impossible to know a home’s actual value until a licensed appraiser inspects it. Many unforeseen factors, such as structural defects or changes in the local housing market, can influence a home’s value. The exact value of a home can only be determined by a professional appraiser.
Appraisal Contingency Explained
Lenders usually need an appraisal before approving your loan. They base the amount they are willing to lend you on a percentage of the property’s appraised value, not on the amount you offer.
For instance, if you make a 20% down payment, they may approve you for a loan-to-value (LTV) ratio of 80%.
- If the appraised value matches your offer, it will cover the rest of the purchase.
- But if the appraisal returns lower than expected, you may have to make up the difference if you still want to go through with the sale.
The appraisal contingency allows you to change or withdraw your offer if the appraised value is significantly less than expected.
Benefits of an Appraisal Contingency
1. Protection for the Buyer
An appraisal contingency ensures that the buyer is not overpaying for the property and provides a way to back out of the deal if the appraisal is significantly lower than the purchase price. If the house doesn’t appraise, the contingency creates an opportunity to renegotiate the purchase price or terms based on the appraisal results, potentially leading to a better deal for the buyer.
The cost of the appraisal is low compared to the value of this option.
2. Financing Security
Many lenders insist on an appraisal before granting a mortgage. An “appraisal contingency” is a provision that allows the buyer to secure financing based on the property’s market value. This contingency allows the buyer to receive a refund for their earnest money deposit if the home does not appraise at the expected value.
Appraisal Contingency Example
You find a great house in a perfect neighborhood, but it’s in a hot market with competition from other buyers. You consult with your broker and offer $10,000 above the asking price, and the seller accepts it. Your bank has already approved you for a loan-to-value ratio (LTV) of 85% with a 15% down payment.
You then sign the purchase contract, including an appraisal contingency, and schedule an appointment with an appraiser. However, the appraiser discovers a mold problem in the home, which will significantly affect its value.
The appraiser reveals that the home’s value is $40,000 less than the asking price, making your offer $50,000 higher than the appraised value. Since the bank will only lend you 85% of the appraised value, if your offer was for $250,000 and the home is worth only $200,000, the bank would only approve you for $170,000.
Without an appraisal contingency, you must pay the additional $80,000 out of pocket, including your down payment. However, with the contingency clause, you can make a counteroffer based on the new information or back out of the sale.
Waiving vs. Using an Appraisal Contingency
1. Times to Use an Appraisal Contingency
It’s important to consider including an appraisal contingency when buying a primary residence. This can help you avoid financial challenges if the property is appraised for less than the purchase price. Sellers typically expect this contingency in the purchase agreement, and it can protect you from financial risk.
2. Times to Waive an Appraisal Contingency
It is generally recommended that buyers include an appraisal contingency in their offers. However, there are certain situations where it might be appropriate to waive this right.
For example, suppose you are paying in cash and intend to demolish the existing property or undertake a complete renovation. In that case, you may skip the appraisal to expedite the closing process.
Another scenario where you might not need an appraisal contingency is if the home was recently sold and the lender grants you an appraisal waiver. You would not need to include an appraisal contingency in your offer. Additionally, suppose you are facing intense competition from other buyers and want to make your offer more attractive. In that case, you might consider waiving the appraisal contingency in exchange for a quicker closing. However, if you are financing the purchase, be aware that if the appraisal comes in lower than expected, you may need to cover the difference out of pocket.
Other Types of Contingencies
- Financing Contingency
- Home Sale Contingency
- Title Contingency
- Inspection Contingency
1. Financing Contingency
A financing contingency allows the buyer to withdraw from the sale if they are unable to secure financing. For instance, if you lose your job after making an offer and your loan is denied. As a result, the financing contingency allows you to withdraw from the sale without facing any legal repercussions.
2. Home Sale Contingency
Remember this: Some buyers include a home sale contingency in the contract. This allows them to back out of the sale if their previous residence doesn’t sell quickly enough. If you’re selling your old home simultaneously, it’s essential to make sure you find a buyer so you don’t have to pay two mortgages.
3. Title Contingency
A title contingency allows a buyer to withdraw or revise their offer if any issues with the property’s title are discovered. For instance, if someone other than the seller claims ownership of the property or has undisclosed liens against the title, the title contingency provides the option to reconsider the offer.
4. Inspection Contingency
The inspection contingency allows you to amend or retract your offer if a home inspection reveals any negative issues. For instance, if you find out that the roof is at risk of collapsing, you can request a credit to cover the repair expenses or choose not to continue with the purchase.
Appraisal Contingency Bottom Line
An appraisal contingency is a crucial protection in real estate deals. It safeguards buyers from overpaying by ensuring the property is worth the agreed-upon price. By including this contingency in the purchase agreement, buyers can renegotiate or cancel the contract or proceed confidently based on the appraisal results. This clause helps ensure a fair and transparent transaction for buyers and sellers.
Georges has been working in Wall Street for the last 16 years trading derivatives with hedge funds. He has been an active real estate investor for over a decade. Georges graduated from HEC Business School in Paris and holds a master in Finance from ESADE Barcelona.
