Published by Kartik Subramaniam
At its core, a contingency is a condition that needs to be met before an offer like a real estate transaction is allowed to proceed. From a certain perspective it's a bit like a safety net and it's far more important than people realize. For the sake of example, let's say a home buyer visits a property that they absolutely fall in love with. After quick negotiations with the seller, they agree to the purchase price of $350,000. Contracts are drawn up, documents are signed and an initial deposit is handed over. Everything proceeds as it should, until the appraisal comes in... and all parties find out that the house is only worth $300,000. What, in that situation, do you do?
If they had an appraisal contingency in the contract, the buyer would walk away without a care in the world. An appraisal contingency means that if the home you want to buy doesn't appraise for the amount that you've already agreed to pay, you get to walk away from the deal with your deposit in hand. This is because an appraisal determines the fair market value of the home you're trying to buy.
All told, they're a hugely important part of the real estate process for a wide range of different reasons, all of which are worth exploring.
As stated, the purpose of an appraisal contingency is to protect both the buyer and the lender from overpaying for home. No lender will ever want to lend someone more money than a home is worth because from the moment that buyer gets the keys, they'd immediately be underwater. Likewise, no home buyer should ever want to be in that situation because part of the reason you purchase property in the first place is for equity - something that you wouldn't have in that situation.
During the appraisal process, a licensed and trained professional will come to the property in question for what is essentially a physical, in-person inspection. They'll take into consideration specifics like the condition of the outside and inside, the size of the yard, home improvements that have been recently made and more - all in an effort to determine the current fair market value of the property. They'll also take a look at any recent renovations that have been made, or additions that have been built since the last time the home was appraised.
Note that an appraisal is not the same thing as a home inspection and they should not be treated as such. They're similar, to be fair, but they serve different purposes.
Overall, these contingencies protect people financially if there's a serious difference in value between what the home is worth and what they're actually being asked to pay.
Having said all of that, there are a few key situations when using an appraisal contingency as part of a real estate transaction may not be a good idea.
Chief among them is if you're buying when it is a seller's market - particularly one that is as active as it is right now. A seller's market, as the name suggests, means that there are often multiple offers for a single some and buying competition is high. Right it's extraordinarily high - driven in large part by the combination of historically low interest rates and the scarcity of inventory across the country. Things have gotten to the point where it's not uncommon to hear about a situation where a buyer doesn't just waive an appraisal contingency - they waive a home inspection as well. Obviously, this won't always be the case - but it's also the perfect example of when an appraisal contingency will probably lose you a home.
When a seller has the ability to choose between multiple, similar offers in a market that favors them greatly, they're obviously going to choose the one that is the most beneficial to themselves. Any offer that comes with strings attached like an appraisal contingency is obviously less appealing to that person. If you really love a home, you can strengthen your offer by waiving your appraisal contingency. You must also, however, be willing to risk a lower appraisal when that day comes.
You may also consider waiving an appraisal contingency if you're buying a home with cash. Cash sales don't actually require an appraisal because there is no lender involved to deny a mortgage if there is a big difference between what the home is worth and what you're paying for it. Obviously, you could always run the risk of overpaying to begin with - but so long as it's a risk you're willing to take on, this would be considered appropriate.
In the end, the appraisal contingency is one of the more complicated parts of the real estate process - but it's also one of the more important for the protections that it offers. It's also a perfect example of why it's so important to work with a trusted real estate professional to begin with. They can help navigate the market, helping buyers to understand when and why to use things like the appraisal contingency and others. It's just another in a long line of examples of how they assist home buyers in enjoying all the benefits of this process with as few of the potential downsides as possible.If you would like to become a real estate agent, read our success stories to learn more about what the real estate career is like.
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