Appraisal Contingency
TLDR: An appraisal is the safety net that allows you to walk away from the transaction (and prevents you from overpaying) if a property does not appraise for the amount that you’ve agreed to pay for it.
If you’re obtaining a loan, it's highly likely that the lender will order an appraisal, an independent assessment of the value of the property. If you’re not getting a loan, you’ll need to locate and hire an appraiser yourself. The appraisal serves as a safety net: it confirms that the property is worth what you've agreed to pay for it. The protocol is for an appraiser to inspect the house in person and compare it to other similar properties that have sold in the vicinity. They will analyze this information and estimate the the property's value (in the form of a dollar figure), which they will provide to you and to the lender.
The appraiser will not give this information to the seller. However, you may end up sharing the results later if you're asking the seller to reduce the sales price based on the appraisal.
What happens if the house appraises for more or less than the agreed upon sales price?
Assuming you've included an Appraisal Contingency or you have a Financing Contingency that requires an appraisal, these are the potential outcomes.
Example: The property didn’t appraise high enough
Let's say you've agreed to pay a seller $215,000 for a house. However, the property only appraises for $205,000, which means the lender will only lend up to $205,000*. If that happens, your options include:
A. Come up with the difference ($10,000) in cash.
B. Ask the seller to lower the price to the appraisal amount, $205,000. They'll likely want to see the appraisal before they agree to lower the price.
C. Some combination of A and B; maybe you can't afford to pay $10,000 out of pocket, but you can afford an additional $5,000 in cash. The seller could meet you halfway by dropping the price $5,000.
D. If you included an appraisal contingency, you can walk away from the transaction and get your earnest money deposit back. Your contingency allows you to end the contract if the property doesn't appraise.
If you forewent an appraisal contingency, you’ll lose your EMD if you terminate the sale.
*Most lenders require a down payment so they would not actually lend $205,000, they would lend up to a proportion of $205,000. If you're putting down 10%, that means they would only loan 90% of $205,000, not 90% of $215,000.
Tip
If the house doesn't appraise for the purchase price, the seller is likely to be willing to negotiate. Why? Because if one appraiser deemed the property less valuable than the sales price, it's likely that other appraisers will come to the same conclusion. If you terminate the contract, the seller will need to find a new buyer all over again, and risk the same issue.
Example: "Comps"
Here’s an example of an appraisal, which compares recently sold properties (Comparable properties, commonly referred to as “comps”) to determine the value of the subject property.
How much?
Appraisals generally range from $400-600.