First the good news: You’ve made an offer on a home and the seller has accepted. You’ve signed a contract and paid a deposit, usually a few thousand dollars.
Now for the not-so-good news: The appraiser says the house is worth less than your offer — and the bank won’t grant a mortgage. Enter the appraisal contingency, which protects you in situations just like these.
What is an appraisal contingency?
Contingencies are conditions that must be met before a real estate contract becomes legally binding. Most real estate contracts include three conditions:
- The appraisal contingency stipulates the house must be appraised at the sale price or higher, which will help you secure a mortgage. Depending on the agreement, this contingency could also include a provision that the sale price will be reduced to the appraised value if the appraisal is lower.
- The finance contingency states that the deal depends on the bank granting a loan.
- The inspection contingency requires the home to pass an inspection. This might also include a provision that there can be no more than a certain dollar amount required in repairs, or that the seller must remedy any issues (or reduce the sale price).
If these conditions aren’t met within a specified time frame, the deal is off, and you are entitled to a refund of your deposit, sometimes called earnest money. Depending on the contract, you might also be entitled to additional money for your trouble.
How do appraisal contingencies work?
Typically, your bank will hire a licensed appraiser to determine the market value of the home, based on its general condition, location and the sales price of similar properties in the area known as comparable sales, or comps. In other words, the appraisal is based on the typical behavior of buyers in the market (not what the seller thinks the home is worth).
Let’s say you’re buying a house for $300,000 with a $30,000 down payment and a $270,000 mortgage. If the house is appraised at $260,000, the bank will only loan that amount — leaving you $10,000 short. If the seller refuses to lower the price to make up the difference, the appraisal contingency allows you to walk away and get your deposit back.
Doesn’t the finance contingency accomplish the same thing?
The finance contingency sometimes covers the same risks as the appraisal contingency. If the home is appraised at less than your offer and the bank refuses to write a mortgage, you can exit the deal — but, it’s possible that the bank will agree to a smaller loan that will meet the finance contingency. The seller can then demand that the difference be paid by you, the buyer. If you don’t have the extra cash and there is no appraisal contingency, you are in breach of contract and can lose your earnest money deposit.
That’s why appraisal contingencies are almost always included in a contract, regardless of whether there is a finance contingency.
As with the appraisal contingency, pay attention to the language in the finance contingency. It should only obligate you to obtain a mortgage within a certain range of interest rates and with a specified down payment. If you’re the seller, this contingency should include a time frame for the buyer to get a mortgage.
How long is an appraisal good for?
Because an appraisal is a real-time valuation, it becomes outdated — but exactly when depends on the local market and how fast it shifts. Often, the lender sets the time frame, which can range from 60 to 120 days, and commonly no longer than six months, at the longest.
Why do appraisals become outdated? When appraisers assess comps, they generally include recent sales. Because of that, your appraisal can “expire” in as little as a few days, especially in a fast-moving market. You might need to foot the bill for a new valuation if there are delays in underwriting, so it’s important to be responsive to your lender’s requests during this time.
Keep in mind that there are cases when an extension is necessary, so your lender may not order a second valuation. Also, different loan types, such as FHA loans, may have their own requirements. Always check with your lender so you meet their specific standards.
What can I do if an appraisal is too low?
Although both parties can walk away from a deal that fails to meet the appraisal contingency, they may not want to. In this case, you can petition the bank to reassess the value of the home. Ask for a second appraisal while presenting evidence you think makes the house worth more — such as comps the appraiser might have missed, or features that are hard to see, such as radiant-floor heating. Alternatively, you can hire your own appraiser. If the second appraisal deems the house more valuable, you might be able to secure a loan for the full amount you need.
Should I waive the appraisal contingency?
It’s best to exercise patience instead of waiving contingencies, even in a hot real estate market. While eliminating the appraisal contingency could give you an edge, you’re taking on the risk that you might not get the loan you hope for, and sellers might require proof that you have the cash to cover a deal.