An appraisal contingency is an essential safeguard in many home purchase contracts. It protects buyers by allowing them to back out of a sale or renegotiate if the property appraises for less than the agreed-upon price. This clause is especially important when a buyer is financing the purchase through a mortgage lender, who relies on the appraisal to confirm the property’s market value.
Here’s how an appraisal contingency typically works:
- Offer Acceptance: The buyer and seller agree on a purchase price, and the buyer includes an appraisal contingency in the purchase contract.
- Appraisal Ordered: The mortgage lender requests an independent appraisal to assess the home’s current market value based on comparable sales, size, condition, and features.
- Appraisal Results: If the appraisal matches or exceeds the contract price, the sale progresses as planned. However, if the appraisal is lower, the contingency allows the buyer to take specific actions.
When the appraisal comes in below the purchase price, buyers can:
- Renegotiate: Request the seller to lower the price to the appraised value.
- Pay the Difference: Cover the gap between the appraised value and sale price out-of-pocket.
- Cancel the Contract: Walk away from the deal and typically recover their earnest money deposit.
Sellers also benefit from appraisal contingencies because they reduce the risk of deals collapsing due to financing issues. When the appraisal doesn’t support the contract price, it forces realistic negotiations upfront and signals buyer commitment to secure financing.
In competitive markets, some buyers waive appraisal contingencies to strengthen their offers, but this involves significant financial risk since they must cover any shortfall if the appraisal is low.
For clarity, appraisal contingencies differ from home inspections. While appraisals estimate value for lenders, inspections assess property condition for buyers.
Including an appraisal contingency with clear terms on timelines and buyer options is crucial unless paying fully in cash. Buyers should understand their protections and potential outcomes when the appraisal falls short.
For further details, see our Mortgage Contingency article for related buyer protections.
References:
- Consumer Financial Protection Bureau, What is an appraisal?
- Investopedia, Appraisal Contingency
- NerdWallet, Appraisal Contingency: What It Is And How It Works