Appraisal Contingency: What Is It, And Should You Waive It?

Let’s say you find and make an offer on your dream home. Even better, the seller accepts your offer. You sign the purchase contract, pay a deposit to show you’re a serious buyer, and see the finish line of the home-buying process.

The only problem? Your dream home appraises for less than the sale price, and now your lender won’t approve your mortgage loan.

Here’s the good news: If your purchase agreement includes an appraisal contingency, you have several options – which we’ll explore momentarily.

What Is An Appraisal Contingency?

An appraisal contingency – like other real estate contingencies – is a condition that must be met before a real estate agreement can become a legally binding contract and the home purchase can proceed to closing.

Specifically, an appraisal contingency is presented by you, the buyer, and states that your offer is contingent on the appraised value of the home matching or exceeding the amount you’ve agreed to pay. If the fair market value of the property is lower than your offer, an appraisal contingency protects you from overpaying for the home. It also lets you opt out of a transaction without being penalized for doing so.

Of course, the seller can choose to accept or reject your appraisal contingency or any other contingency you might propose when making an offer on their house.

What Is A Contingent Offer?

When you make an offer on a home, you typically put a small percentage of your down payment into an escrow account. This earnest money – or good faith deposit – lets the seller know your offer is serious.

A contingent offer allows you to walk away from a real estate contract with your earnest money in the event the conditions of the offer aren’t met. Generally, a contingent offer can go one of the following ways:

• The seller rejects the offer. In this case, you can counteroffer, make a no-contingency offer or walk away. If you choose to walk away, you get to take back your good faith deposit.
• The seller agrees. If the seller accepts your contingent offer and the house meets all the contingent requirements, your earnest money deposit will go toward your down payment or closing costs.
• The seller agrees, but you change your mind. If all conditions are met but you decide you don’t want the house, you’ll have to forfeit your earnest money deposit.

An appraisal contingency is just one of several contingencies that can be tacked onto a purchase agreement. Other types of contingencies include a mortgage contingency, title contingency, home inspection contingency, financing contingency and home sale contingency.

How Does An Appraisal Contingency Work?

Once your offer – including your appraisal contingency – has been accepted and a purchase agreement has been signed, your mortgage lender will order a home appraisal. An appraisal protects your lender from authorizing a loan amount higher than the property’s value.

Depending on the type of appraisal your lender orders, a licensed appraiser will determine the home’s fair market value based on several factors, including the general condition and location of the property and any comparable sales – or comps – in the area.

Up next, we’ll take a more in-depth look.

Appraisal Contingency Example

Let’s say you make an offer of $250,000 on a home. You put down 10% – or $25,000 – and plan on your lender providing you a mortgage with a principal balance of $225,000. However, your lender will only loan you an amount at or below the fair market value. So if the home only appraises for $210,000, you’ll be $15,000 short.

Without an appraisal contingency, you may not be able to walk away – at least not without forfeiting your deposit. Under some conditions, you may have to go through with the transaction and pay the difference out of pocket.

What To Do If The Appraisal Is Lower Than Your Offer

An appraisal contingency gives you the option to walk away with your earnest money deposit if the house appraises for lower than you were hoping. However, this contingency also gives you some negotiating power. You may want to pursue one of the following options before backing out:

• Petition for a second appraisal. To have your request for a second appraisal approved, you’ll need evidence – such as recent multiple listing service (MLS) data or documentation of renovations and other improvements the seller has made – to support your belief that the first appraisal may have been wrong. Speak with your real estate agent for advice when considering a second appraisal.
• Negotiate the sale price. If you can’t get a second appraisal – or if it also came in low – you’ll need to negotiate with the seller. Ideally, you’ll convince them to lower their asking price so that it meets the appraised value and your lender will agree to finance the home loan.
• Cover the difference. You can offer to make a larger down payment to offset the difference between the sale price and appraised value. Using the earlier example, if the appraised value is $210,000 and you requested a mortgage of $225,000, you’d need to increase your down payment by $15,000.
• Meet in the middle. If you can’t afford to cover the entire difference upfront, you may see if the seller is willing to meet in the middle. For example, instead of paying an additional $15,000, you might offer to increase your down payment by $7,000 if the seller can agree to reduce the sale price by $8,000. You could also ask for a seller concession – for example, you might ask the seller to pay more of the closing costs so you can cover the difference.
• Walk away. If you and the seller can’t reach an agreement – or the lender doesn’t approve the new terms – you may have no option but to walk away from the transaction. This decision may delay your plans of homeownership, but you can at least take your deposit with you when you go if there’s an appraisal contingency.

Should You Waive An Appraisal Contingency?

While advisable in most real estate transactions, an appraisal contingency isn’t required. In fact, waiving the appraisal contingency may be necessary to strengthen your offer in a hot real estate market.

Let’s explore when you should use an appraisal contingency and when it might make sense to waive the appraisal contingency clause.

When To Use An Appraisal Contingency

In most instances, you’ll want to exercise the appraisal contingency. Especially when:

• You’re buying your first home. If you’re a first-time home buyer, the safety net an appraisal contingency provides can make the buying process simpler and less stressful – especially when making an offer.
• Your offer maxes out your budget. If the home is on the upper end of your price range, you may not have enough funds to cover the difference in the event of a low appraisal. An appraisal contingency gives you more negotiating power and offers you an escape route if you and the seller can’t reach a deal.

When To Use No Appraisal Contingency

Ultimately, you’ll want to get advice from your real estate agent or REALTOR^®, but waiving an appraisal contingency may make sense in the following scenarios:

• You’re buying in a seller’s market. In a seller’s market, the homeowner may have their choice of offers, so a contingent offer likely won’t be as competitive as it would be in a buyer’s market.
• You’ve found your dream home. If you’re in love with a home and can financially afford to risk a lower appraisal, waiving your appraisal contingency may increase the chance of a seller accepting your offer.
• You’re buying with cash. Most lenders require an appraisal. But if you’re buying a house with cash, you won’t need a lender and can therefore forgo an appraisal.

The Bottom Line

Appraisal contingencies protect you from overpaying for a home by giving you options if the appraisal comes in lower than your purchase price. Given that a home purchase is an investment that may last for decades, an appraisal contingency is one of the best safeguards for ensuring your long-term financial health.

Are you ready and eager to get the ball rolling on a home search? Start a mortgage application with Rocket Mortgage^® to find out how much you qualify for and determine the kind of offer you can make.