Homebuyers will do just about anything in today’s housing market to get a leg up on the competition. A shortage of homes available for sale across the U.S. means many markets are seeing multiple offers, properties selling fast and sale prices well above asking.
For many homebuyers, raising an offer price still isn’t enough to guarantee a seller will accept their bid. Inspection contingencies are being waived, the time to close is shortened and, in some cases, the appraisal contingency is waived as well.
But is waiving an appraisal contingency a good idea — or even possible — if you’re financing your purchase with a mortgage? Here’s what you need to know about appraisal contingencies, when you may be able to waive one and what you should know before you do.
What Is an Appraisal Contingency?
An appraisal contingency is a clause in a home purchase contract that gives the homebuyer the option to back out of a pending sale if the property’s appraised market value is less than the agreed-upon price.
It’s often seen as a risky investment to pay above the appraised value for a home, and lenders use the appraisal as a determining factor for what they’re willing to provide for a home purchase. “A bank, when they make a mortgage, will make a decision based on the lower of either the purchase price or appraised value,” says Melissa Cohn, executive mortgage banker for William Raveis Mortgage on the East Coast.
In many cases, homebuyers who are financing their home purchase with a mortgage do not have the excess cash to make up the difference. If the difference is relatively small, buyers may try negotiating the price down with the seller to keep the deal from falling through. But if all else fails, the appraisal contingency gives the buyer an easy out when the appraised value is too low.
Why Would You Waive an Appraisal Contingency?
In a strong seller’s market, where there are more buyers than homes available for sale, the seller has the upper hand. Buyers have to craft their offers carefully to compete with each other for a home, and houses often sell for above asking price.
By waiving an appraisal contingency, the buyer is able to appeal to the seller by eliminating the chance that the deal would fall through if the property doesn’t appraise for the elevated sale price. “It’s not necessarily waiving the appraisal,” says Kevin Parker, vice president of field mortgage originations for Navy Federal Credit Union in Vienna, Virginia. “You’re waiving the opportunity to negotiate if the property doesn’t appraise (for the sale price).”
In the current market, waiving an appraisal is almost a requirement, depending on where the property is and how many buyers are interested. “There are some sellers who are willing to give appraisal contingencies, but I see it not often at all,” Cohn says. She adds that winning offers, for the most part, involve all-cash offers “basically with no contingencies.”
[Read: The Guide to Earnest Money.]
Should You Waive an Appraisal Contingency?
When you finance a home purchase with a mortgage, your lender depends on the appraisal to know it’s not lending more than the property is worth.
“Based on my experience, I believe it is important for a buyer to not waive an appraisal contingency,” wrote Carrie Firth, a real estate agent with Coldwell Banker Realty in Pensacola, Florida, in an email. “The appraisal is done for a reason. The purchaser should be aware of the value of the home they are buying. They may be able to negotiate or reconsider their decision if the value doesn’t meet the purchase price.”
Waiving the appraisal contingency isn’t the only option for making an offer more enticing. “A purchaser may consider having a flexibility of a closing date, covering additional seller’s costs in the transaction or shortening the inspection period,” Firth says.
If you’re purchasing the home with a mortgage and waiving the appraisal contingency, you’ll need to be confident that the amount you’re offering is an accurate valuation of the property and that you have extra cash to make up the difference if the appraisal comes back lower.
Here are a few situations that can make waiving the appraisal contingency an OK choice:
You Know the Market Well and Are Making a Reasonable Offer
The biggest risk to you as the homebuyer when waiving an appraisal contingency is the chance that you’re stuck with making up a large difference between the appraised value and the sale price. Take advantage of publicly available information on recent sales of similar properties in the neighborhood on sites like Zillow, realtor.com and Redfin, and use a real estate agent you trust to help you determine an offer price you believe to reflect the value of the home. This knowledge will help you make a more confident offer, but you should still have a cushion of extra cash in case the appraisal shows other information.
Parker says he recently purchased a home and his knowledge of the neighborhood and any sales that recently happened there made him feel more confident in waiving the appraisal contingency. “You should absolutely be very familiar with that market. In my situation, I moved three blocks down in my community,” he says.
You Have Enough Cash to Guarantee Making Up the Difference No Matter What
You may be able to cash out some other investments, have sizable savings or have family that can lend you cash in the short term, but you can waive the appraisal contingency in your purchase contract if you know you can make up any difference in the appraisal and purchase price with cash. The appraisal will still happen, but the sellers know they won’t have to worry about the result.
You Qualify for Fannie Mae or Freddie Mac’s Appraisal Waiver Programs
Fannie Mae and Freddie Mac both offer appraisal waiver programs, making it possible for mortgage approval to occur without an appraisal. Both Fannie Mae and Freddie Mac will permit some mortgages to be supported with a valuation conducted in-house, rather than by a third-party appraiser. However, eligibility is limited, and the majority of home purchases do not warrant a waiver.
You Qualify for a Separate Appraisal Waiver Through Your Lender
Individual banks, credit unions and other lenders may offer an appraisal waiver through other programs than those that Fannie and Freddie offer. Again, expect the qualifications to be pretty limiting — a very high credit score and high equity in a home you already own are possible requirements.
You Qualify for Other Lender Programs That Make Waivers Easier
Lenders know how tough the market is for buyers right now, and while they don’t want to make a bad investment, some are offering programs to help buyers win a contract. Cohn says William Raveis Mortgage has a program called Raveis Purchase, which allows buyers to make a contingency-free, cash offer on a home. The program is best for borrowers with high equity in their current home — the program means the lender will purchase the current property and oversee its sale.
William Raveis ultimately makes between 3% and 5% of the sale price of the home, and the seller is responsible for all additional costs and broker fees, but the program can “help those buyers that need to be able to act as though they are a cash buyer,” Cohn says.
As you shop around for mortgages, it’s worth inquiring about programs like this that you may qualify for to make any offer on a new home more appealing.
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