Making an offer on a home is a huge deal. Having the seller accept that offer is an even bigger deal. In a matter of weeks or months, you could become a homeowner. However, before you start jumping for joy, you should understand the different contingencies you should include in your contract. One of the most important is the appraisal contingency. Without it, you could find yourself in deep financial trouble or worse yet, have legal troubles on your hand.
What is an Appraisal Contingency?
Just like any other contingency, an appraisal contingency gives you a way out of the purchase contract should the appraised value not come back as high as the purchase price. You might wonder why this would matter – there’s one simple reason, the financing.
A lender can only lend you as much as the value of the home. If you agreed to pay more than the value of the home, the difference is on you. The unfortunate part is that you won’t know the appraised value until long after you signed the contract. It takes the lender to order the appraisal and the appraiser to get in contact with the seller to actually do it. By this point, your contract is legal and binding, leaving you in the lurches for financing.
The appraisal contingency gives you a certain amount of time to get out of the purchase contract without any legal or financial consequences. You must have the appraised value back in your hands before the expiration date of the contingency, though, that’s the only problem.
How the Appraisal Contingency Helps
Here’s how the appraisal contingency can you help you. Let’s look at an example.
John puts a bid on a house for $200,000. The seller accepts the bid and they both sign the purchase contract. The contract is now a binding legal agreement. John did not put any contingencies in the contract, so he is ‘required’ to purchase the home by the date in the contract. John plans to put down 3.5% on the property, as he is getting FHA financing. At this point, his down payment is $7,000.
When the appraisal comes back, it shows that the home John is to purchase is only worth $185,000. John was supposed to secure financing for $193,000. The home doesn’t support that size loan. Because John did not add a contingency to the contract, he still has to buy it. This means he has to come up with the difference in the down payment. The lender will be able to provide financing for $180,375. If the contract stands as is, John would need $19,625 for a down payment.
Now, John could back out of the contract, but since he is in breach of contract, he would lose any earnest money he put down on the home.
Now, if John had the appraisal contingency on the contract and the appraisal came back short, like it did, he would not have to buy the home. He would have two options:
- Try to renegotiate with the seller
- Back out of the contract
If John decided to back out of the contract, he would be able to get his earnest money back and walk away from the sale.
Other Contingencies you Can Use
Aside from the appraisal contingency, there are others you have to consider as well. The appraisal is probably the most important as it has a direct bearing on your loan. The others are also impactful though and they include:
- Inspection contingency – This gives you a specific period to secure an inspection and review the results. If something comes back as dangerous or that you just don’t like, you can ask the seller to fix it or back out of the contract without issue.
- Financing contingency – This gives you time to secure proper financing. If something pops up that makes the lender rescind their offer to provide you with financing, you can back out of the contract without a problem.
Any type of contingency can protect you in a very costly purchase. If something doesn’t go right, you can back out of the contract, keeping your money in your pocket. Talk to an attorney about the contingencies that suit your situation the most, including the appraisal contingency. This way you have your self-protected no matter what happens moving forward.