This sponsored, biweekly Q&A column is written by Andrew Goodman, Associate Broker and top producing agent with Gallagher & Co. Real Estate, Inc. Based in Bethesda, Andrew serves clients in Maryland, D.C., and Northern Virginia. Please submit comments, questions, and opinions in the comments section or via email.
Question: I am at the beginning stages of the home buying process and my Realtor has expressed the possibility of needing to waive the appraisal contingency in order to win a bidding war. Do you mind explaining to me the pros and cons of the appraisal contingency and why it would be recommended for me to remove it from my offer?
Sure, I would be delighted to. With today being a seller’s market, it’s quite understandable that your realtor would suggest the removal of the appraisal contingency. However, it is risky. Let me tell you why.
First, let me explain what an appraisal is. An appraisal is a third party’s unbiased evaluation of the current market value of the subject property. An appraisal is done by an appraiser hired by the lender. The appraisal is used to determine how much the borrower can obtain for a mortgage on the subject property, assuming the purchaser is obtaining a mortgage on the property. Depending on the loan program, the lender will typically lend up to 100 percent of the appraised value.
An appraisal contingency protects the buyer’s interests in the event that the appraised value of the home comes in below the contract sales price. If the appraisal contingency was waived and the appraised value was less than the contract sales price, the buyer would have to pay the difference between the appraised value and the contract sales price via cash. If that is not an option and/or the buyer chooses not to proceed with the transaction, the buyer’s earnest money deposit could be at risk. In the event that the contingency is in tact, four things could happen if the appraised value comes in low:
- The seller could drop the sales price to the appraised value.
- The buyer could pay the difference between the appraised value and the contract sales price with cash.
- The seller and buyer could negotiate and agree on something in the middle.
- If nothing were agreed upon, the contract would be considered null and void.
If the appraisal came in at or above the contract sales price, no further action is needed and the transaction would proceed as usual.
So to answer your question, the pros of having an appraisal contingency from the buyers prospective are:
- Protection of the earnest money deposit in the event of a low appraisal.
- Avoiding coming up with the cash to pay for the difference between the appraised value and the contract sales price.
The cons of the appraisal contingency, in itself, are strictly on the seller. The seller’s risks would be for them having to lower the sales price to save the transaction or the deal falling apart in the event of a low appraisal.
Now, let me show you an example of how a low appraisal can make once a great purchase turn into an ugly one quickly. Lets use the example that you are purchasing a single-family home for $800,000, you plan on putting 20% down, and you have a $35,000 earnest money deposit in escrow. When making the offer on the property, you are planning on bringing $160,000 (for your 20% down-payment) plus your closing costs to settlement.
Let’s say the appraisal came in at $750,000 and you don’t have an appraisal contingency or any other means of contractual protection. You will now need to bring the 20% down of the $750,000 or $150,000 plus the difference of the appraised valued and the contract sales price or $50,000 plus your closing costs. So your thought of bringing $160,000 plus closing costs, now just turned into $200,000 plus closing costs or you could lose your $35,000 deposit.
(On a side note, with a low appraisal, make sure you revisit with your lender because when you reduce your loan amount you may be able to change your loan terms/program which could save you on your monthly payment, down payment, and interest rate on the loan.)
There are many different opinions on the appraisal concept and whether they truly due give an accurate portrayal of the market value of the property. Unfortunately, there are many factors in today’s Bethesda market that I find difficult for the appraisal to judge based on just comparable homes that have recently sold. However, the appraisers are trying to abide by the rules and regulations set for them and until those regulations adjust for times like today, the real estate market, buyers, sellers, lenders, brokers, etc., will have to deal with it.