What to Know about a Home Appraisal Contingency

Potential home buyers face a number of decisions prior to submitting an offer, and some of those decisions involve contingencies. A contingency is a stipulation in a contract that impacts whether or not the contract can be fully executed. In previous posts, I wrote about mortgage contingencies, inspection contingencies, and sale and settlement contingencies. An appraisal contingency can be included with an Agreement of Sale if a buyer requires a mortgage to purchase a home.

For the 74% of buyers in the U.S. who will need financing to purchase their dream home, most will include an appraisal as part of the process. An appraisal is an estimate of fair market value for a property conducted by a professional not affiliated with the transaction in the state where the property is located. Most times, an appraisal is ordered by a lender prior to settlement to ensure the value of the loan matches the value of the property prior to a sale, however, there are a number of other scenarios that may require appraisals: refinances, pre-listing fact-finding, settlement of property in divorces, and estate planning.

A buyer using conventional financing can submit an appraisal contingency with an Agreement of Sale. The main component of an appraisal contingency is determining how the value of the home compares to the amount of money a buyer is asking for a lender to provide.

If a buyer is using an appraisal contingency, they will have an appraisal performed on a property within 30 days (or sooner if a shorter closing) of the executed contract. The appraiser will provide the lender with a detailed report. In the contingency addendum, the buyer will state that the agreement is contingent on the appraisal meeting the contract price or a specific amount below the contract price if the buyer has additional funds to make up the difference. The difference between a contract price and an appraised value is what’s known as an appraisal gap, which can impact whether or not a buyer is able to continue with a sale.

In terms of the contingency, if the appraisal comes back with a value that is equal to or greater than the contract price or the stated value below contract price, the transaction resumes on schedule. The buyer agrees to cover any gap by either providing additional funds at settlement, adjusting the loan amount stated in the mortgage or contingency paragraph in the Agreement of Sale, or adjusting the Loan-to-Value Ratio (LTV). In order to cover the appraisal gap, the buyer will put more money down to make up for the difference in the two values.

With the contingency, if an appraisal is completed and comes in low, the buyer can terminate the agreement or enter into a new agreement with the seller to account for the difference. If the buyer does not terminate or agree to new terms, they waive the appraisal contingency.

If the buyers is using an FHA or a VA loan, an appraisal contingency is already built into the contract language because these loans are backed by the government. If the home does not appraise for the value in the contract, the buyer has the right to terminate the contract with all deposit money returned.

Buyers should consult with their real estate agent and lender prior to submitting an offer to determine if the appraisal contingency is necessary, but in many scenarios the buyer should consider it in order to protect themselves from entering into a contract for a home they may not be able to afford. In the current market landscape in the Philadelphia region, many home prices are still trending up, so it’s likely the sale price will be higher than previous comparable sales, thought the amount of the difference may vary between markets and transactions.

The gaps should not be as high as they were two to three years ago when sale prices exploded, but clients of mine submitted and offer this week on a home that went for over $90,000 above asking price.

If you’d like to learn more about contingencies for buyers, sign up for my Contingency Workshop on September 25th at www.gregoldfield.com/buyersworkshop1