What Is an Appraisal Rider in a Real Estate Contract?

What Is an Appraisal Rider in a Real Estate Contract?

An appraisal rider serves as a specific addendum to a purchase agreement. This document addresses potential discrepancies between a property’s agreed-upon purchase price and its professional appraised value. It provides a framework for how the transaction proceeds if the appraisal does not meet the contract price. The rider is a modification to the primary sales contract, outlining terms related to the property’s appraised value. It helps manage expectations and establish a predefined course of action for all parties involved.

Understanding the Appraisal Rider

An appraisal rider is a contractual provision within a real estate purchase agreement. Its purpose is to safeguard either the buyer or seller, or both, if a property’s independent appraised value is less than the price agreed upon. Mortgage lenders require an appraisal to ensure they are not lending more money than a property is worth, as the home serves as collateral.

The rider specifically addresses the “appraisal gap,” which is the difference between the contracted purchase price and the lower appraised value. Without such a provision, a buyer could be obligated to purchase a home even if it appraises for significantly less. The terms of an appraisal contingency, often outlined in a rider, include details such as the agreed-upon value, the timeframe for the appraisal, and procedures for resolving discrepancies.

Scenarios for Inclusion

Appraisal riders are frequently incorporated into real estate contracts in market conditions where property values are rapidly changing or uncertain. In competitive buyer’s markets, where demand outstrips supply, buyers often make offers significantly above the asking price. These aggressive offers increase the likelihood of an appraisal gap, making an appraisal rider a valuable tool.

Bidding wars also contribute to the common use of appraisal riders. When multiple buyers compete for a single property, offers can escalate beyond what an independent appraisal might support. Including an appraisal rider helps a buyer’s offer stand out while providing a mechanism to address a potential low appraisal. It signals a buyer’s willingness to proceed even if the valuation is lower than the contract price, under certain conditions. Uncertainty about a property’s true market value, due to unique features, limited comparable sales, or a rapidly appreciating market, can also lead to the inclusion of an appraisal rider.

How an Appraisal Rider Operates

When an appraisal rider is part of a real estate contract and the property’s appraised value comes in lower than the agreed-upon purchase price, the rider’s terms dictate the next steps. The buyer typically receives a copy of the appraisal report, and then various options become available. The specific structure of the appraisal rider determines the actions that can be taken.

One common structure is “full appraisal gap coverage,” where the buyer agrees to cover the entire difference between the appraised value and the purchase price. This means the buyer will bring additional cash to closing to make up the shortfall, as lenders usually only finance up to the appraised value. For example, if a home is contracted for $400,000 but appraises at $380,000, a buyer with full gap coverage would pay the $20,000 difference in cash.

Alternatively, “partial appraisal gap coverage,” or capped coverage, limits the amount the buyer is willing to pay. Under this arrangement, the buyer agrees to cover a specific portion of the appraisal gap, such as up to $10,000 or $20,000. If the gap exceeds this capped amount, the buyer may then have the option to renegotiate the price with the seller, or terminate the contract.

A more aggressive approach involves the buyer agreeing to “waive the appraisal contingency” entirely. This signifies that the buyer will proceed with the purchase regardless of the appraised value, taking on the full risk of a low appraisal. If the appraisal is low, the buyer is still obligated to close the transaction at the original purchase price, requiring them to cover any difference in cash. If no agreement can be reached on the price or gap coverage, and the rider allows, the buyer may have the option to terminate the contract and receive their earnest money deposit back.

Buyer and Seller Considerations

For buyers, an appraisal rider presents a strategic decision with financial implications. Agreeing to cover an appraisal gap, whether fully or partially, means the buyer must have sufficient liquid funds available to pay the difference in cash at closing. This can impact the buyer’s overall financial planning and may necessitate a higher down payment or adjustments to other financial goals. Buyers should carefully assess their financial capacity before committing to such terms.

Sellers benefit from appraisal riders by receiving stronger offers in competitive markets. An offer with an appraisal rider, particularly one that includes gap coverage, provides greater assurance that the deal will close even if the appraisal is low. However, sellers also face the risk that if the appraisal is significantly low and the buyer is unwilling or unable to cover the gap, the transaction may still unravel. Buyers must weigh the desire to secure a property against the potential financial exposure of a low appraisal. Sellers must balance the appeal of a robust offer against the possibility of renegotiation or a failed transaction if the appraisal does not align with the purchase price.