Should you waive your Appraisal Contingency? What is a Contingency? | Housing Market 2021
You’ve submitted your offer, and you just received a counter from the seller, and it says that they want you to remove your appraisal contingency—should you? Today, let’s talk about contingencies, specifically the appraisal contingency, and how to responsibly remove this contingency to make a competitive offer.
I think people are not looking at this the right way when they talk about eliminating contingencies. They’re thinking, “I have to disarm myself of all my rights to be competitive.” To me, that’s actually backward. I want to share with you why and also how you can strategically remove contingencies and put yourself in a stronger position to succeed when you’re making those offers.
What is an appraisal contingency?
In a nutshell, contingencies are your escape valve. They’re your legitimate way out of the contract should something happen or something not happen. In the case of an appraisal contingency, the bank will make you pay for an appraiser whenever you pursue a loan. The appraiser will give an independent opinion of your home’s present value. They will then get your contract and know what you’re paying for the house to be able to do their job: support that value using the house’s location, size, upgrades, etc.
To do the appraisal, they will take the measurements of your house, look at the upgrades, pull similar homes that have sold recently, and then try to justify the price per square foot and make all the different adjustments needed. However, if they can’t and they have no choice but to come in with a low appraisal, that is where your appraisal contingency comes in.
With the appraisal contingency, it’s like you’re simply saying that you’re going to hold to your escape valve on your side of the table until you get someone to verify you are paying a “fair price.” That is until the bank independently verifies that what you’re paying for this house is a fair value relative to what the comps say and what the market says.
So, should you remove your appraisal contingency?
Now, with prices pushing up as high as they are, it’s terrifying to consider removing this contingency. Many times when you’re writing offers, you have to leapfrog the last comp to remain competitive. Also, you’re going a little higher and a little higher each time. No one wants to be the person left out in the cold when it comes to that low appraisal and be the first person not to get the assessment, right? Because admittedly, most houses are appraising right now. I have also not seen too many that are coming in low. And if they are coming in low, they’re not really coming in drastically low. We’ll get to that in a second, but in a nutshell, that’s what the appraisal contingency is. It’s your legitimate way to get out of the contract or negotiate for a lower price, typically if the appraisal comes in low.
Why would sellers want you to remove your appraisal contingency?
Obviously, sellers don’t like this contingency because it means that they don’t have a sure deal. They’re not guaranteed to get the money that you offered them in the first place. It’s all very loose and very tumultuous– like there are no guarantees. They don’t want that, and because they have all or most of the power in this market, they can demand that you remove it.
What are your options?
There are two sides to this appraisal conversation that I think are really, really important to consider. The first one is obviously the market side, and the second one is your cash position as the buyer.
1. Things to consider on the market side
What comps are available? How does this house stack up relative to other houses that have sold? Is it better? Is it a fixer? Does it have a better floor plan? Is it on a better street or larger lot? Were the other ones on busy roads? What was the price per square foot average for that neighborhood? How much are you paying over or under that so you can make that determination with your agent and decide, “Are we paying a premium?” Is this pushing the price boundary for the neighborhood? Are we setting a price record here? Is there a pending sale that may close before ours that we could potentially use to justify the value?
Those are the type of things you need to find out. Also, here’s a pro tip:
- If you see some pending sales around your house, make sure you or your agent call someone on that transaction and find out the price it’s going to close for and when.
By having that information, you can more confidently bid and justify a price based on what is going to close in the future. You can then make an offer based on those comps, as opposed to older ones, that other would-be buyer are not going to know about, necessarily.
2. Things to consider regarding your cash position
The other side of this is your cash position as a buyer. How much is your cash on hand? What are your assets? How much do you have available to complete this transaction?
What does that mean specifically? For example, for a $1,000,000 purchase where you’re going to put 20% down, you need $200,000. You also have some closing costs, and if you’re in a jumbo loan scenario, you have a higher reserve requirement, as well. Talk to your lender to better understand what that means, but for now, know that it’s not just the 20%.
Then, let’s say the appraisal comes in at $950,000. Now, your bank will say, “Okay, the fair market value we believe for this house is $950,000, and so we’ll give you the 20% down on the $950,000.” That scenario is great if you have an appraisal contingency because you can negotiate something with the seller.
However, if you don’t, you’re now on the hook to make up that difference back up to that original contract price of $1,000,000. Let’s suppose you’re somebody who only has 20% for the down plus maybe just a little bit for the closing costs and cannot liquidate a retirement account or borrow some money from a family member. This mean’s you don’t have a lot of wiggle room. In cases like this, the seller could go after your earnest money and try and take it. It’s not quite that simple but that’s a discussion for another time. Just know that it sucks and you don’t want to go there.
How can you prevent that from happening?
What you need to do strategically is look very seriously at the comps. Think in advance about what the appraiser is going to see. What’s the price per square foot they’re going to apply? Is there a part of this house that has a lower ceiling? Or maybe parts that weren’t done with a permit?
Look for very noticeable things that will make the appraiser give you a lower value per square foot. Ask yourself, “Are we paying a big premium over the other comps or is this justified?” Look at where you think it’s going to go, then look at your cash. Ask yourself, “What’s the worst-case scenario we could come up with that if it came in low, could we bring up the difference?”
And if you’re comfortable and have the financial ability to make up for that difference, then you might be an excellent candidate to safely and responsibly remove your appraisal contingency. On the flip side, it is probably not responsible for you to remove that contingency if it puts you into a position where you are “house rich” but “cash poor,” have no rainy day funds.
When writing the offer, it’s really a strategic decision that you and your agent need to make. It critical to know your financial ability, the market’s ability to sustain what you’re offering, and then come to a logical conclusion together.
One last tip to remember
For my last piece of advice, I just want to point out that most houses are appraising. I have seen a handful that has come somewhere between $20,000 to maybe $50,000 short. That’s a lot of money, especially when you’re already putting down $200,000 or more. You want to take that very seriously and look at the numbers.
If you know that you’re paying a premium, do yourself a favor: run the numbers a few different ways. Look at it as many times as you have to and get sober on the fact that you might have to bring some extra cash to the table to finish this deal off. However, that doesn’t necessarily mean you made bad purchase. It only means that you love the house, and it’s going to be worth that much to you, personally.
So do some soul searching and run the numbers. Look at it very seriously and know the downside. Because if you name it and claim it, most of the time, it loses its power. You can then make an excellent vital decision and put yourself in a more secure and potentially more advantageous place when it comes to writing offers.
I hope my blog on the appraisal contingency has helped you.
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