There’s nothing quite as exciting as placing an offer on a home you’d love to own. When that happens, you and the seller sign an initial purchase agreement outlining the terms of the deal.
What are contingencies in a real estate contract?
Every homebuyer would like to enter into a purchase contract knowing all the details about the property beforehand. However, there is no real way to do that until after the seller agrees to an initial offer, and that’s where the contingencies come into play.
In short, a contingency is a condition or a specific action that must occur before the contract becomes legally binding. The homebuyer places a contingency in the offer that provides an “out” if a need to withdraw the offer arises.
In general, contingencies include factors such as a home inspection and an appraisal value. An appraisal contingency requires that the home’s appraisal meet the expectations of the buyer.
The purpose of an appraisal contingency
An appraisal contingency is the most common type of contingency and one that is part of nearly any real estate contract. It allows you to be sure that the property has a certain market value. During an appraisal, a third-party, often hired by the mortgage lender, will determine the value of the home. The appraiser is not concerned with the sale price of the home, just the home’s market value.
The details of the contingency are in the contract. For example, it may specify the amount of time the homebuyer has to make a decision after receiving the appraisal. It may also provide other requirements, such as terms that give the homebuyer an opportunity to cancel the contract. If all the contingencies are met, the homebuyer accepts the appraisal and the loan moves forward.
When the appraisal is lower than the sale price
If the appraisal shows the home is valued below the specified amount, the homebuyer can cancel the purchase. Any money paid to the seller at this point can be refunded. In many cases, the mortgage lender will not approve a loan for a home that is valued below the sale price.
In some situations, the seller is given the opportunity to adjust the home’s sale price to match the appraised value. But the seller is never obligated to do that and can walk away from the offer.
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If the contingency isn’t met
When any contingency is not met, all parties involved in the contract have the ability to walk away. There are no legal consequences to this, and there is no breach of contract. On the other hand, if the conditions are met, the contract is legally enforceable. With appraisal contingencies, mortgage lenders generally play a role in the decision about whether to move forward.
With all real estate transactions, there is some leeway for moving forward. If you do not agree with the appraisal, you may request a second one, perhaps with additional information. At the same time, the buyer may decide to increase the down payment on the purchase, reducing the mortgage amount. This can satisfy the lender and allow the deal to move forward.
Appraisal contingencies provide a safety net to ensure the home is not bought for more than its true market value, which would add too much risk for most lenders.