The Appraisal Contingency
What is an appraisal contingency? When it comes to purchasing a home, there are various contingencies that buyers can (and should) include in their offer or purchase contract to protect themselves from potential risks of being forced to proceed with the transaction or risk losing their good faith deposit. Individual contingencies can be shortened, or even waived, and the decisions regarding how to structure your particular offer are specific to what’s best for you and your own individual transaction. An appraisal contingency, though, is an important clause in a home purchase contract that allows a buyer to walk away from the transaction if the home does not appraise for the purchase price, and typically retain their good faith deposit, having it refunded following cancellation of the contract. It is essential to understand that this contingency is separate from a financing contingency, which provides protection for the buyer in case they are unable to obtain financing. The financing contingency, though, does not afford protection in relation to the appraisal. An appraisal contingency is a separate contingency, even though the appraisal, is more times than not, a lender requirement. You do not want to find yourself in a position where a low appraisal is the sole reason that you cannot obtain your financing and not have an appraisal contingency protecting you. If you’re advised, at any point, to waive the appraisal contingency because you have a financing contingency and that the lender will require an appraisal anyway, you must know this is a dangerous practice that puts your good faith deposit at risk. If the buyer's financing is declined due to a low appraisal and they do not have an appraisal contingency, they could lose their deposit.
What About the Right to Renegotiate?
Now, there is a lot of confusion and misinformation about the appraisal contingency, and some mistakenly believe that it gives them the right to renegotiate the purchase price if the appraisal comes in low. This is not the case, as, at least in California, there is no built-in verbiage or expectation that the seller will, or must, agree to renegotiate. Logistically, it would seem to make sense that a seller should be open to renegotiating price should an appraisal come back lower. Many times, in fact, the seller does. Those instances, while they do happen, should not be misconstrued as any obligation on the part of the seller. The appraisal contingency allows for the buyer to walk away from the purchase of the home and cancel the transaction if the appraised value comes back lower than the purchase price. (1)
What is a Home Appraisal?
It is important to understand that the appraisal is an independent, neutral evaluation of the property's value, and neither the buyer nor the seller has any control over it. (2) This is a result of industry changes implemented by the Dodd-Frank Act following the financial crisis. There are countless articles out there that will lead you to believe that the appraiser determines the value of the property. There is a distinction here that needs to be mentioned. When an appraisal’s purpose is intended for a refinance transaction, the appraiser’s role is to estimate the home’s value. (3) The fact of the matter is for a purchase transaction, though, the value of the property has already been determined and established by the process of marketing the home and contracting for the sale of the home with a ready, willing, and able buyer. The appraiser’s actual role, pertaining to a home purchase, is to determine whether the agreed upon sales price is supported by the recent and most relevant local market activity. The appraisal result is an opinion of the randomly selected appraiser that’s backed up with facts and statistics in the appraisal report that they produce. Although one might be pretty assured of what the report might look like based on self-analysis of the available facts and statistics, the opinion that counts the most is an unknown until the appraisal report is in hand. Therefore, it is highly recommended that buyers include an appraisal contingency in their purchase contract, unless they are paying all cash or making a substantial down payment and are confident that the property will appraise for the purchase price.
Should You Waive Appraisal Contingency?
People often ask should appraisal contingency be waived. Obviously, there are pros and cons and some significant risks. In some cases, waiving the appraisal contingency can make a buyer's offer appear stronger and eliminate an unknown for the seller. However, this decision should be made carefully and based on a thorough assessment of the risks involved. The unknown still exists. The buyer's good faith deposit is at stake, and the decision to waive any contingency should be based on the specific circumstances of the transaction and the individual buyer's situation. There can really be no reasonable blanket advice when it comes to this topic. The decision to potentially waive an appraisal contingency has to have factored in everything specific to the transaction and the buyer.
The Bottom Line
An appraisal contingency is a crucial protection for homebuyers that allows them to walk away from a transaction if the home does not appraise for the purchase price. It is separate from a financing contingency and should not be waived unless the buyer is paying all cash or making a substantial down payment and is confident that the property will appraise for the purchase price. Real estate agents should provide accurate information and advice to their clients about the importance of the appraisal contingency and the risks involved in waiving it. It’s important to note that processes, contingencies, rules, regulations and procedures can and do vary state by state. As with most things real estate related, it’s of utmost importance to engage and consult with a local expert.
