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An appraisal contingency protects homebuyers from overpaying for a house in an unstable market. This clause is included in purchase contracts and gives the buyer the right to walk away from a deal if the home appraises below the sales price. If you're planning to buy a new home soon, it may be a good idea to include an appraisal contingency in your purchase agreement.
Keep reading to learn more about how appraisal contingencies work, when they should or shouldn't be used and what to do if the appraisal comes in lower than expected.
How an Appraisal Contingency Works
An appraisal contingency protects the buyer during the homebuying process. Generally, the seller will require an earnest money deposit if they accept your offer to purchase their property. If you decide to back out of the transaction without an appraisal contingency, you could forfeit your deposit and be subject to additional penalties.
Having an appraisal contingency in your purchase contract could get you off the hook, however. It notifies the buyer of your intention to have the property appraised before moving forward with the transaction. It also grants you the right to walk away consequence-free, and get your earnest money back, if the property fails to appraise for at least the amount you've offered to pay.
To illustrate, suppose you hire a licensed home appraiser to assess a property you've offered to pay $400,000 for. After reviewing the property you intend to purchase and other comparable properties in the area, the appraiser assigns a value of $325,000. Since lenders typically won't approve a mortgage loan for more than a home is worth, you may have to walk away from the deal. That is, unless you're able to make up the difference with either a down payment or a sales price reduction.
When to Use an Appraisal Contingency
An appraisal contingency can protect you during a hot housing market, especially if the home you're interested in is close to your maximum budget.
When the demand for new homes exceeds the supply, bidding wars are common and can drive up the price of the available listings. If you make an offer on a home with an inflated asking price, you'll have options. The appraisal contingency will force the seller to adjust the asking price, or risk having you walk away with your deposit.
When to Waive an Appraisal Contingency
It's not always necessary to include an appraisal contingency in your purchase agreement. In fact, waiving an appraisal contingency could make your offer more appealing to sellers. Still, it should only be done in certain situations.
If you're in good financial standing and have the funds to close on the property, even if the appraisal comes in low, you can waive the appraisal contingency. This is most common for buyers paying cash for a property or making a down payment big enough to cover any gap between what you offer and the home's appraised value.
You can also waive the appraisal contingency if you're financing the home through the seller, but be mindful that this could cause issues down the line if you decide to sell the house.
What Happens if the Appraisal Is Low?
When you're ready to move forward with the purchase of a new home, a low appraisal may cause a lot of stress. You have options, though, depending on whether you have an appraisal contingency.
Your first move could be to request a second appraisal if you believe the first appraisal is incorrect. If the second appraisal is low, you can cancel the contract and get your deposit back. You also have the option to negotiate the sales price or pay the difference in cash if the seller doesn't budge to save the deal.
Without an appraisal contingency, walking away from the sale would cause you to forfeit your earnest money deposit.
The Bottom Line
An appraisal contingency is a valuable tool for homebuyers. It shields you from financial loss if you put an offer on a home and it appraises for less than the sales price. This clause gives you the option to negotiate a better deal or cancel the contract without consequence, but it may put you at a disadvantage against other buyers who don't have one.
You may ultimately choose to omit the appraisal contingency clause from the purchase agreement to make your offer more appealing. Before deciding to waive an appraisal contingency, speak with your real estate attorney regarding any questions or concerns you may have.