A home is more than just another purchase – it’s an investment in the truest sense of the term. As is true with all investments, it needs to be protected. This is why appraisals are so important.
Think about it like this. A home is perhaps the largest single item that someone will ever purchase in their lives. Even if they’re not planning on having their current property act as their “forever home,” they still can’t afford to lose money by overpaying on a house that isn’t worth nearly what is being asked.
Appraisals act as a way to prevent that from happening. An appraisal contingency takes this idea one step further, offering a wide array of benefits that cannot be ignored.
First, it’s important to come to a better understanding of the function that home appraisals serve in the real estate process.
Obviously, a seller wants to get the highest possible amount of money for the home they’re about to part with. A homeowner, on the other hand, wants to get the best deal that they can. A home appraisal is an opportunity to have an objective third party enter the situation – one who is not affiliated with either person – to provide an accurate representation of what the home is actually worth.
A home appraiser is someone who has been both licensed and trained who physically visits the property in question. They’ll examine it from the top down and will look at not only the condition of the inside and outside but also the size of the lot and more. They’ll take into consideration any improvements that have been made in recent memory and will compare them to recently sold homes that are similar in the surrounding area.
They use information about these comparable homes to develop a fair value given the current conditions of the market. Usually, they’ll take a look at home sales that have taken place within the last three to six months. Then, they’ll compare what they’ve learned to everything they know about the current condition of the home in question to come up with fair market value.
Note that this is an entirely separate process from something like a home inspection. The easy way to think of it is that an appraisal is entirely focused on determining the true value of a home. A home inspection, on the other hand, is all about the functional quality of the home. An appraiser might consider that a home has an HVAC system, but a home inspector would be able to tell you that it only has an estimated five years left on its lifespan.
Again, the appraisal process is in service of coming to an objective value for the home to make sure that buyers don’t pay anymore than it is actually worth. It’s also critical because most mortgage lenders won’t actually offer a loan for more than the home is actually worth, making appraisals a requirement for most buyers.
An appraisal contingency, by association, is a condition built into the real estate contract that both buyers and sellers will need to adhere to. Essentially, it allows a buyer to back out of a contract if the appraisal comes back with a value that is different from the agreed upon purchase price.
For the sake of example, let’s say a buyer agrees to buy a property for $500,000. They’re even able to put forward $100,000 for a down payment. Everything seems to be proceeding along exactly as it should… until the property appraised at $400,000.
This immediately becomes an issue if the buyer’s mortgage company refuses to offer a loan for 100% of the remaining balance. If the buyer cannot come up with the difference themselves, they would either have to come up with the additional money out of pocket or the entire deal would fall apart.
Without an appraisal contingency, this becomes a tricky legal matter given the presence of a contract. With one, it’s simple – the buyer is able to back out without issue.
That’s not to say that the buyer leaving the negotiating table is exactly what would happen. A few different options are still in play. The buyer could always try to renegotiate the sale price of the home to account for the difference in the purchase price versus the appraisal price. This does, however, depend on the seller being willing to lower the price to take into consideration this new information.
If one buyer’s appraiser came in with this specific value, it’s likely that another appraiser would have similar opinions – meaning that the seller is probably going to run into similar issues down the road. It would be in their own best interest to at least consider renegotiation, but there’s absolutely no guarantee that will happen.
Note that the buyer would also likely run into an issue getting a mortgage in this scenario as outlined above.
Nevertheless, appraisals – and by association, appraisal contingencies – are a crucial part of the home buying and selling process. They’re intended to protect everyone involved from a bad transaction and to help avoid buyers from being taken advantage of.
Yes, having a home appraise for less than the purchase price included in a real estate contract will be a disappointing situation for all involved – but it is a reality that does happen from time to time. By planning ahead and having a plan in place for if and when it does occur, it helps everyone involved make the best possible decision in the moment.
If you’d like to find out more information about what appraisal contingencies are and why they matter so much in the fast-paced modern world of real estate, or if you just have any additional questions that you’d like to go over with someone in more detail, please don’t hesitate to contact us today.