What Is the Appraisal Contingency Clause?

When engaging in the complex process of purchasing a home, buyers and sellers often encounter various conditions that shape the real estate agreement. These conditions, known as contingencies, serve as protective clauses within a contract, ensuring certain requirements are met before a transaction can be finalized. They function as a safety net, allowing parties to back out of a deal without penalty if specific circumstances are not satisfied. Including these clauses in a purchase agreement helps safeguard financial interests and provides flexibility during the home-buying journey.

Defining the Appraisal Contingency

Among protective clauses in real estate contracts, the appraisal contingency is a significant safeguard. This clause allows a homebuyer to withdraw from a purchase agreement, or renegotiate its terms, if the property’s appraised value comes in lower than the agreed-upon purchase price. Its purpose is to protect the buyer from overpaying and to shield the lender from extending a loan for an amount exceeding the property’s actual market value.

The appraisal contingency is particularly important when financing a home purchase, as mortgage lenders require an appraisal to ensure the property serves as collateral for the loan. Lenders base the maximum loan amount on the appraised value, not the purchase price, to minimize their financial risk. Should the appraisal fall short of the sales price, the buyer’s ability to secure the full loan amount can be jeopardized. This clause allows buyers to exit the deal with their earnest money deposit intact if the property does not appraise adequately.

The Appraisal Process and the Contingency

The home appraisal process typically begins after a seller accepts a buyer’s offer and financing has been initiated. The buyer’s mortgage lender usually orders the appraisal through an independent, state-licensed appraiser or an appraisal management company for an unbiased evaluation. This step is distinct from a home inspection, as an appraisal focuses on determining the property’s market value rather than identifying repair needs.

The appraiser conducts a thorough assessment, including an on-site inspection of the home’s interior and exterior to evaluate its condition, size, features, and upgrades. They also research comparable recently sold properties, “comps,” in the immediate area to establish fair market value. These comparable sales, along with public records and market trends, inform the appraiser’s professional opinion on the home’s value.

After inspection and research, the appraiser compiles findings into a detailed report, submitted to the lender and typically shared with the buyer. The appraisal process, from order to report delivery, can take anywhere from a few days to several weeks, commonly ranging from 6 to 20 days. If the appraised value matches or exceeds the agreed-upon purchase price, the appraisal contingency is generally satisfied, and the transaction can proceed to mortgage underwriting.

Outcomes of the Appraisal Contingency

When a home appraisal results in a value lower than the agreed-upon purchase price, often called an “appraisal gap,” the appraisal contingency becomes particularly relevant. This situation can complicate the transaction because lenders will typically only finance up to the appraised value, not the higher contract price. Buyers and sellers then have several options to consider, each with its own financial implications.

One common approach is renegotiation, where the buyer and seller work together to adjust the purchase price. The buyer may request the seller to lower the sale price to match the appraised value, or they might agree to meet in the middle. This option is often preferred as it allows the deal to move forward without requiring additional out-of-pocket funds from the buyer or jeopardizing the loan amount.

Alternatively, the buyer can choose to pay the difference between the appraised value and the purchase price out-of-pocket. This means the buyer brings additional cash to closing to cover the “appraisal gap,” ensuring the lender’s loan amount, based on the lower appraisal, combined with the buyer’s down payment and extra cash, equals the original purchase price. While this allows the transaction to close, it requires the buyer to have sufficient liquid funds available and increases their immediate financial outlay. A seller might contribute funds towards the buyer’s closing costs to help bridge a portion of the gap.

If no agreement can be reached or if the buyer is unable or unwilling to cover the difference, the appraisal contingency allows the buyer to terminate the contract. Exercising this right enables the buyer to walk away from the deal without penalty and receive their earnest money deposit back. This protection is a benefit of including the contingency.

However, waiving an appraisal contingency significantly increases the buyer’s financial risk. Without this clause, if the appraisal comes in low, the buyer could be forced to cover the entire appraisal gap in cash or risk losing their earnest money deposit if they cannot or choose not to proceed. Waiving the contingency makes an offer more attractive to sellers, especially in competitive markets, but it transfers substantial risk to the buyer.