What is an appraisal contingency?

When buying a home, the act of making an offer is far from the final step in the process. Even if the seller accepts your offer, you may find that you're not ready or not willing to make the purchase official. That's why potential homebuyers are allowed to add "contingencies" to their offer, protecting them in case something goes wrong before closing.

There are many different types of contingent offers. One type of contingency that is specifically designed to protect buyers is the appraisal contingency. Including an appraisal contingency clause in your offer has its benefits, but some drawbacks as well.

What is a contingency?

If a buyer makes an offer with a contingency, that means the home sale will only go through if certain conditions are met.

Real estate contingencies allow buyers to back out of the sale if something goes wrong without losing their earnest money deposit. There are a few types of contingencies:

• A financing contingency, also known as a loan contingency, means that if the buyer has trouble getting a mortgage for the home purchase, they can drop out of the contract with no penalty.
• A home sale contingency lets existing homeowners make an offer on a new home that is contingent on selling their old house, so they can avoid overlapping housing costs.
• An inspection contingency gives buyers the ability to negotiate repairs or cancel the contract based on the results of a home inspection.
• An appraisal contingency states that if the appraised value of the home is lower than the purchase price, the buyer can negotiate the purchase price or walk away at no cost.

All of these contingencies are important and valid. Here, we're focusing on appraisal contingencies due to how important they can be for the buyer. A low home appraisal is an excellent reason to back out of purchasing a potentially overvalued house, or renegotiate the sale price before it's too late.

How does an appraisal contingency work?

Appraisal contingencies are a tool for buyers and their lenders. If a buyer is getting a mortgage to help them purchase a home, their lender will only extend that financing if the property is worth their investment. Lenders do this by assessing the appraisal value of the home.

As part of this process, the lender will ask an appraiser to determine the value of the house. The lender will only give the buyer a mortgage up to the appraised value of a home, regardless of the proposed purchase price. This is to ensure they aren't lending more than what the home's worth.

Thus, an appraisal contingency protects the buyer if there is a low appraisal and they can't get enough financing from their lender.

For example: Let's say a buyer and seller agree on a sale price of $300,000, but the appraisal comes in at $280,000. The buyer's lender will not give a mortgage that covers this $20,000 difference, or appraisal gap. If the buyer has an appraisal contingency, they have the option of canceling the purchase contract without losing their deposit.

What happens during an appraisal?

The buyer's lender will typically hire a third-party company to perform the appraisal. The appraiser will evaluate the property based on its general condition, location, and comparable sales to determine the home's fair market value. The whole process can take 2-4 weeks, from the lender ordering an appraisal to the appraiser submitting their report. The actual in-home visit takes anywhere from 15 minutes to a couple of hours, depending on the property.

Appraisers can also review the property remotely. This is called a desktop appraisal, and its become more common in the post-COVID era. This does not require a second appraisal, as remote appraisals should deliver a report that satisfies the mortgage lender.

After the appraiser has done their due diligence, they'll release their appraisal report. This report is sent to the buyer, their real estate agent, the lender, and in some cases, the seller and their real estate agent.

Should buyers waive their appraisal contingency?

If you're a homebuyer looking to make a competitive offer, an appraisal contingency could hold you back. That's because sellers usually prefer contingent-free bids that give them more certainty that the sale will go through without a hitch. If presented with multiple offers, and one has an appraisal contingency clause (or any other contingency), the seller may be more likely to choose the one without a possibility of falling through last minute.

Some buyers in hot real estate markets choose to waive their appraisal contingency to get a competitive edge. For most of us, this might just be too risky of a move.

Remember, having no appraisal contingency means you agree to pay the contracted sales price of the home, even if your lender isn't willing to lend you the full amount. If you don't have the cash on hand to cover the difference, you'll be forced to break the real estate contract and forfeit your deposit, which could mean losing thousands of dollars.

→ Learn more about waiving an appraisal

Homebuying with no appraisal contingency

Contingencies, regardless of the kind, present a sort of dilemma. They help a potential buyer ensure that their investment in their potential new home is safe and secure. However, for sellers, a contingent contract means there's a good chance that the sale could fall through for many reasons.

If you want to buy a home without contingencies, you take on a lot of risk. If there is anything wrong with the home, but you've agreed to buy it, you won't have much recourse unless you've put contingencies in place.

So is it possible for buyers and sellers to avoid contingencies with no downside? You could become a cash buyer and not require any sort of mortgage loan (and thus no appraisal) in order to secure your new home. This still leaves you vulnerable to issues with a home that an inspection contingency can protect against, however.

Working with a company like Orchard can help you avoid a home sale or financing contingency as well. If you're selling a home and looking to buy a new one, start by finding out how much your home is worth.