When you buy a home, it’s often a good idea to include some contingencies in the purchase contract. These contingencies protect you should something go wrong after you sign the contract. They give you a ‘way out’ if certain situations occur. One popular contingency is the appraisal contingency.
Keep reading to learn what it is and if you should include it in your purchase contract.
What is an Appraisal Contingency?
The appraisal contingency gives you a set time to have the appraisal done and time for you to review the report. This is an important contingency because if the appraised value comes back less than what you bid on the home, your financing could fall through. Lenders don’t want to lend you more than the home is worth as that leaves them in a bad financial position.
If you were to default on your loan and you were already upside down, the lender stands to lose quite a bit of money. Typically, when a lender takes over a property, they already take a loss. The home doesn’t usually sell for its full market value. If the lender is already upside down on the home because they have a larger mortgage on the property than the home is worth, it’s like a double loss.
What Happens With the Appraisal Contingency?
Let’s look at an example to see how the appraisal contingency works.
John bid $250,000 on a home. The seller was asking $275,000, so John feels comfortable that the home should appraise for at least $250,000. The lender orders the appraisal on the property only to find out that the home is worth $230,000. The seller has the home listed too high. The bank tells John that they will not write him a loan if he buys the home for $250,000. They will base the loan off the $230,000 purchase price.
If John had the appraisal done and read the report before the appraisal contingency expired, he has the chance to back out of the sale and not give up his earnest money. If he decides after the appraisal contingency expires, though, he does stand to lose his earnest money. This is why it’s important to pay close attention to the dates.
What Happens if You Waive the Appraisal Contingency?
If you decide that you want to buy the home no matter what, you can waive the appraisal contingency. This may give your offer more credibility, especially if there are several other buyers looking to buy the home. Sometimes buyers feel the pressure to give up the contingencies just so the seller will accept their bid.
If you do waive the contingency, though, and the home doesn’t appraise for the full value of your bid, you are still required to buy the home. You can back out of the transaction, but you will likely lose your earnest money. The seller gets to keep it in exchange for taking the home off the market while you had a purchase contract on it.
You may want to execute your right to negotiate with the seller to lower the sales price of the home if the value doesn’t support the current bid. There is nothing that requires the seller to lower the price, though. Which leaves you on the hook for the difference between the sales price and the appraised value, putting you in a negative equity position from the start.
So should you waive the appraisal contingency? We don’t recommend that you do. It’s an important contingency that protects your investment should the appraisal not provide the value you were expecting. While it may weaken your offer in the eyes of the seller, it protects you in the end.Click to See the Latest Mortgage Rates»