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The Appraisal Contingency – What it Really Means

NOTE:  This post was originally posted in 2010, but still very relevant

The appraisal contingency is a standard clause in most real estate purchase agreements. It is a clause that essentially says “this contract is subject to the property appraising at the contract sales price (or more), or the contract may be canceled by the buyer”. While the intent is fairly clear, what is less clear is what happens if the appraisal comes in below the sales price.

First of all, a disclaimer. The appraisal in question generally refers to the bank appraiser assigned by the buyer’s lender to appraise the property as part of the loan process. If the buyer is paying all cash, they can still include an appraisal contingency, and contract to have the property appraised as part of the purchase. While sellers often wish it to be so, this clause does not apply to a previous appraisal obtained by the seller, either as a preemptive measure or as part of a refinance or purchase. Prior appraisals are not used to satisfy the appraisal contingency. In fact, as written about previously, the bank appraiser is independent of the lender, and seller for that matter. In theory, thanks to the recent changes in the appraisal process, appraisers have absolutely no contact with the lender. This is in order to avoid manipulation or undue influence on the valuation. So, if the appraisal comes in at the sales price or greater, the condition is essentially satisfied and the buyer can not cancel the agreement on that basis.

But what happens if the property does not appraise for at least the sales price? It is really up to the buyer. The buyer can cancel the agreement. If the appraisal comes in low, the buyer may question the value of the property and become uncomfortable with the price they are paying. In this situation, it is not uncommon for the buyer to elect to cancel the agreement outright, especially if there are other factors that have made the buyer second guess the purchase (such as inspection issues, or job instability, etc). And they have every right to do so under the contract. Or the buyer may have to cancel the agreement if they don’t have the resources to complete the purchase. If the buyer is putting a set amount down (5%, 10%, or 20%), they may not be able to obtain the loan stipulated, even if they want to proceed at the higher sales price. When a property appraises less than the sales price, then the lender bases their loan on the appraised value, not the sales price. For example, say the sales price is $1,000,000, and the buyer is getting an 80% loan (or $800,000). If the property appraises for say $900,000, then the lender will only lend $720,000 (or 80% of the appraised value). The buyer would have to come up with the additional $80,000 in order to purchase the property at $1,000,000. If the buyer has the resources to fund the difference, they can still elect to proceed with the purchase, even though the purchase price is higher than the appraised value.

The buyer and seller can also negotiate a compromise or alternative course of action. There is no contractual provision for the seller to mandate another appraisal, or to appeal the valuation, or to force the buyer to purchase the property at the contract sales price. Any mitigation of the appraisal situation requires the consent of the buyer. Certainly, the appraisal is just an opinion (theoretically a highly educated one) of the value of the property. And appraisers are human, and fallible, and the quality of an appraisal does vary. Many times, the parties can challenge the appraisal by providing the lender (and/or appraiser) alternative sales comparables that justify a higher price, or correcting errors in the original appraisal report. It also might be possible to order another appraisal on the property that will hopefully come in at the sales price, but the buyer and seller would have to agree who will pay for it.

Perhaps the most common solution to a low appraisal is to negotiate a new purchase price. Sometimes the seller is forced to lower the purchase price to the appraised value or risk losing the buyer. Sometimes, the parties settle on a price between the sales price and the appraised value. Where this negotiation goes has a lot to do with current market conditions. If it is a hot market, and there are other potential buyers interested, then the seller is not likely to be too flexible in terms of adjusting the sales price. But if the market is slow, and there are not many buyers in that price segment, the seller would be wise to be open to adjusting the price. At the end of the day, a lot will depend on the resources and motivation of both parties. If the buyer wants to buy the house, and the seller wants to sell it, then there is a good chance to overcome an appraisal problem. As long as both parties feel the resolution is fair and just, a low appraisal does not necessarily mean the transaction is dead. It just means there is more work to do, which seems to be a common scenario in these complicated times.