Appraisal Contingencies: What You Need to Know

Picture this: You’ve found your dream home. The seller has accepted your offer and a mortgage lender has pre-approved your loan. Homebuying is a long, involved process and it finally looks like the end is in sight. Except there’s one more hurdle to get over — the appraisal.

Home appraisals can be nerve-wracking for everyone involved. Their purpose is to determine the market value of a house. Sometimes they reveal that a property’s value is less than the potential loan total, making it overpriced based on market value. It’s a tricky situation that can halt the buying process in its tracks. If your mortgage lender’s appraiser determines the property is less than you agreed to pay, it’s known as an appraisal gap. In those scenarios, you might have to pay the difference yourself or renegotiate with the seller to keep the deal afloat.

While your lender’s financing contingency typically covers you in those situations, there’s another option you may want to consider: the addition of an appraisal contingency clause.

What is an appraisal contingency?

An appraisal contingency clause is a condition built into a real estate contract that provides a buyer with the right to walk away from a transaction if the appraised value of the home is lower than the agreed-upon purchase price.

In short, it protects you when the value of the home doesn’t line up with the sale price.

How does an appraisal contingency work?

Home appraisals are a routine and important step in the homebuying process, occurring right before closing. Prior to this step, adding an appraisal contingency clause will notify the seller that your offer on the home is only good if the appraiser’s home value matches or exceeds the amount you agreed to pay. Say the appraiser comes back with a value well below asking price, you can choose to walk away from the deal with your money deposit in hand or negotiate with the seller for a lower asking price.

Is there any benefit to waiving an appraisal contingency?

Considering appraisal contingencies are meant to protect a buyer’s best interests, there aren’t many cases in which there’s a benefit to waiving it. This clause is the only way to guarantee you won’t lose your deposit if the sale falls through.

However, there are a few scenarios where you might consider removing an appraisal contingency clause:

• To make your offer more enticing to the seller.
• If you plan to make a significant down payment.
• If you’re paying in full.
• If you don’t care too much about the appraised value of the house.

VA appraisal requirements

VA appraisals have two purposes. The first is similar to conventional purchases, as they ensure the home is worth the value of your offer. The second is to make sure that the property meets both VA and approved lender guidelines. This way, you are guaranteed a home that meets market value, is safe, structurally sound, and free of health hazards.

Homes must meet the Minimum Property Requirements (MPRs) to be approved for financing. Here’s a look at the major MPRs you should be aware of:

• Residential properties only
• Adequate living space
• Mechanical systems must be safe and usable
• Adequate heating features
• Safe water supply and availability
• Roofing must be adequate and provide reasonable future utility
• Problem-free basements and crawl spaces
• Safe property access from the street
• No health/safety hazards
• No defective construction
• No termites or termite damage present
• No traces of lead-based paint

For a more extensive list and details on the VA’s MPRs, you can check out the VA website.

FHA appraisal requirements

Just like VA home loans, the FHA also has a list of minimum property requirements a home must meet in order for the buyer to receive funding. In short, the home must be safe, sound, and secure. The full list of guidelines is in the U.S. Department of Housing and Urban Development’s handbook. It’s a dense read, so here are a few of the highlights:

• Utilities, including water, sewage, heat, and electricity, must be turned on during appraisal.
• Foundation must be structurally sound.
• Water must drain away from the foundation.
• All appliances function properly.
• Water pressure is adequate, with hot and cold water available.
• Paint isn’t chipping, peeling, flaking, or otherwise defective.
• Electrical outlets and switches function properly.
• Windows must open, close, and lock.
• Roofing cannot leak and must have at least two years of life remaining.
• Attics and crawl spaces have vents and be free from damage.
• No active termite infestation.
• Property must be reasonably free from environmental hazards, odors, and excessive noise.

Is an appraisal contingency worth it?

The whole point of an appraisal contingency clause is to protect homebuyers and lenders from paying more than they should for a home. Deciding to add one to your purchase contract will also give you the upper hand in negotiations, saving you money if the price of a home has been appraised below market value.

Although, it’s worth noting that an appraisal contingency may make your offer less enticing to sellers in a competitive market with multiple buyers bidding on the same home. It's always a good idea to consider all of your options. Be sure to consult your real estate agent before making a final decision to add any contingency to your purchase contract.