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When buying a home, purchasers will be faced with many decisions. One of the primary functions of a real estate agent is to provide knowledge and guidance. Once that dream home is found, it will be your job to help write an offer that has the best chance of getting accepted. To that end, you should focus on how the buyer wants the offer structured.
During your discussions, there will be quite a few essential decisions, such as what contingencies should be included in the agreement. One prominent one will be whether to include an appraisal contingency.
Below, we’ll take an in-depth look at everything you need to know about appraisal contingencies, including the pros and cons, so that you can present them clearly to your client.
What is an appraisal contingency in real estate?
If your client has never bought a home before, understanding what an appraisal contingency is may be foreign. The appraisal contingency is a clause in a real estate contract that states the appraised value of the property must be at or above the purchase price. Otherwise, the buyer will have the option to terminate the contract.
Real estate agents will either write language into the offer stating the home must appraise at or above the asking price or they will include a standardized appraisal contingency addendum.
Appraisal contingencies can be included in real estate contracts, but they are also an implied condition for getting a mortgage. If a home does not appraise for a specific value, the lender may deny buyer financing. The appraisal contingency essentially protects the buyer from overpaying for a property when making a bid for a house and, by extension, protects the lender from borrower default.
A buyer’s agent should perform a comparative market analysis to increase the chances of receiving an acceptable appraisal. While a CMA and appraisal are not the same things, they are both methods of valuing a property.
Should a buyer waive their appraisal contingency?
When a cash buyer waives their appraisal contingency, they are essentially saying that they are confident in the value of the property and do not need to have an appraisal done. There are pros and cons to this decision.
The current local real estate market conditions typically play a role in the decision to waive an appraisal contingency or not. In a robust seller’s market that has numerous bidding wars, waiving an appraisal is often necessary to be in the running to get the house.
Sellers do not want to accept an offer on their home way over the asking price, only to find out the home did not appraise and that the buyers are using an appraisal contingency to back out of the contract. Homesellers like a sure thing and don’t want their sale to fall apart midstream.
A buyer can make their offer far more attractive by waiving the appraisal. Doing so levels the playing field with other buyers who are doing the same. Should they decide to conduct an appraisal anyway, a buyer can provide an appraisal gap guarantee stating that they will pay the difference between the appraised value and sale price, if any, in cash.
In a buyer’s market, waiving an appraisal contingency is usually not necessary. With fewer buyers and more predictable home values, few buyers will consider getting rid of the appraisal contingency.
Pros and cons of waiving a real estate appraisal clause
Let’s look at the advantages and disadvantages of waiving a home appraisal.
Pros of waiving a home appraisal
Having an appraisal contingency in the offer may make your buyers look less desirable in the eyes of the seller and the listing agent. If there are multiple offers on a property, the seller is likely to accept one that is not contingent on their home appraising. Waiving this condition in a bidding war helps level the playing field with cash buyers.
The more contingencies you can eliminate from a real estate contract the better, especially when real estate markets heavily favor sellers. When you waive the appraisal, you’re telling the seller that if there is an appraisal issue, it will not present a problem for them.
Buyers may let sellers know they will put up additional down payment monies to satisfy the lender. Buyers who have the ability to do this generally present much stronger offers than those who can’t.
Cons of waiving a home appraisal
Like most things in life, if there are advantages to something — there are probably disadvantages, too. That’s certainly the case when your buyers decide to waive their appraisal. The appraisal contingency can protect a buyer from making a significant financial mistake.
The appraiser is a professional who is engaged in providing accurate home values. Even though the buyer is paying a certain figure for the home, that doesn’t mean others feel it’s the correct fair market value. The decision to pay the price they’ve offered could be a decision they’ll regret later. Having the appraisal contingency in place protects your buyers’ hard-earned money.
When your buyers fall in love with a home that is at the very top of their budget and the appraisal comes in low, they could be stuck. If they don’t have the ability to satisfy the lender by increasing their down payment, they will have to back out of the transaction and forego their earnest money deposit (EMD).
With an appraisal contingency in place, you may be able to negotiate a lower price for the home. If the market favors buyers and the seller is motivated, they may be willing to drop the price. Having the contingency in place could give you the leverage to negotiate a fairer deal on behalf of your clients.
There are many contingencies in a real estate contract that should be discussed with your buyers. Besides an appraisal contingency, the home inspection and mortgage clauses are two significant ones.
Depending on the type of real estate market, it may or may not be wise to waive them. There will always be pros and cons to these decisions. Be sure that you are providing thorough information so that your clients can be comfortable with whatever decision they make.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell homes for the past 33-plus years. He has been a top agent with RE/MAX Executive Realty, which serves many towns across the state of Massachusetts. Check out his blog.