How Does an Appraisal Contingency Work?

In real estate transactions, the appraisal contingency protects homebuyers’ financial commitment. This standard clause in purchase agreements establishes a condition related to the property’s valuation. Understanding its function helps manage the financial risks of a home purchase.

Defining the Appraisal Contingency

An appraisal contingency is a specific condition written into a real estate purchase agreement. Its primary purpose is to protect the buyer and often the lender by ensuring the property’s value, as determined by an independent appraisal, is at least equal to the agreed-upon purchase price. This clause makes the transaction contingent upon a satisfactory appraisal. It functions as a safety net, allowing buyers to avoid overpaying for a home that an objective valuation deems to be worth less than the contract price.

Without this clause, a buyer could be contractually bound to a price that exceeds the property’s actual market value, potentially leading to financial strain. This contingency, like inspection or financing clauses, allows buyers to withdraw from a deal without losing earnest money under specific circumstances.

The Appraisal Process in a Real Estate Transaction

Once a purchase agreement containing an appraisal contingency is in place, the appraisal process begins. The mortgage lender usually orders the appraisal, as it is a requirement for financing to ensure the loan amount does not exceed the property’s value. While the lender initiates this step, the buyer is generally responsible for paying the appraisal fee, which can range from $300 to $600 for a single-family home. This fee is often paid upfront or included in closing costs.

A licensed appraiser conducts a thorough evaluation of the property. The appraiser performs an on-site inspection, examining the home’s interior and exterior to assess its condition, features, and improvements. They also conduct extensive research, analyzing comparable sales of similar properties in the local area that have recently sold, typically within the last six months. This market data, combined with the property’s characteristics, helps the appraiser determine its fair market value.

The appraiser compiles their findings into a detailed report, which is then delivered to the lender, and a copy is also provided to the buyer. This report states the appraiser’s professional opinion of the property’s value. The determined value is then compared against the purchase price to see if the appraisal contingency has been met or triggered by a lower valuation.

Addressing a Low Appraisal

When a home’s appraised value is lower than the purchase price, the appraisal contingency is triggered, offering the buyer several options. This “appraisal gap” means the lender will only finance a loan based on the appraised value, not the higher contract price. Buyers must then decide how to proceed, facing a shortfall between the financed amount and the purchase price.

One option is to renegotiate the purchase price with the seller. The buyer can propose lowering the sale price to match the appraised value, or a compromise price somewhere in between the original offer and the appraisal. Sellers may be open to this, especially if they are motivated to sell quickly or if market conditions suggest another buyer might encounter a similar appraisal issue. Negotiation often involves formal contract amendments.

Another option is for the buyer to cover the difference between the appraised value and the original purchase price. This means the buyer brings additional cash to closing to make up the appraisal gap, ensuring the lender’s loan-to-value requirements are met. For instance, if a home appraises for $10,000 less than the offer, the buyer would need to provide that extra $10,000 in cash at closing, in addition to their planned down payment and closing costs. This choice suits buyers with sufficient liquid funds committed to the property.

If an agreement cannot be reached, or if the buyer cannot cover the appraisal gap, the appraisal contingency allows termination of the purchase agreement. In this case, the buyer receives their earnest money deposit back, as the contractual condition for the sale was not met. This protects the buyer from a financially disadvantageous or unsustainable deal.

Implications of Waiving the Appraisal Contingency

Waiving the appraisal contingency means the buyer agrees to proceed with the purchase regardless of the property’s appraised value. This removes a significant layer of financial protection from the standard real estate contract. When waived, the buyer accepts the risk that the home’s appraised value could be lower than the purchase price, without the right to renegotiate or terminate.

If the appraisal comes in low after the contingency has been waived, the buyer remains obligated to purchase the home at the original agreed-upon price. This necessitates the buyer covering the difference, the appraisal gap, with additional cash at closing. For example, if a property is offered at $400,000 but appraises at $380,000, and the contingency was waived, the buyer would need to bring an extra $20,000 to closing, beyond their down payment and closing costs.

Failing to secure funds for such a gap can lead to severe financial consequences. Without the appraisal contingency, if the buyer cannot obtain financing for the full purchase price and cannot cover the difference, they risk defaulting on the contract. This could result in forfeiture of their earnest money deposit, typically 1% to 3% of the purchase price. Waiving the contingency can make an offer more attractive to sellers in competitive markets, but it transfers substantial financial risk to the buyer.