What is an appraisal contingency and why is it more important now than ever?

What is an Appraisal Contingency?

Appraisal ContingencyFor those not familiar with what an appraisal contingency is let me give you a simple explanation. An appraisal contingency gives you a way out of a legally binding contract should the home you are purchasing not appraise for at least the contract price.

If you are purchasing a home for $200,000, but it only appraises for $190,000, then an appraisal contingency will allow you to get out of contract. In most cases, you will also have your earnest money returned to you.

Up until now the appraisal that was referred to in the contingency was the appraisal ordered by the bank but this may change now due to how some properties are being valued by the bank for the purchase mortgage.

A New Twist on an Appraisal Contingency

Fannie Mae recently introduced Property Inspection Waivers or PIWs. A PIW consists of the option to forgo a traditional appraisal when getting a mortgage for certain refinance and purchase transactions. The motivation behind this is that it will save the consumer both time in processing the loan and lower the cost of obtaining a mortgage.

One thing to keep in mind is that since you will not be getting a traditional appraisal you may not know what the true market value of the home is. You could be paying more than what it is actually worth.

Another point you may want to consider is that if you agree to the PIW you must sign away your rights to any future litigation against Fannie Mae or your lender because they will be absolved from “future enforcement of representations and warranties on the value, condition, and marketability of the property” according to Fannie Mae, and this is known as “Day 1 Certainty”.

You may be asking yourself what does a PIW have to do with an appraisal contingency? If the bank does not order an appraisal then an appraisal contingency will not help you.

The bank may be satisfied with the data they have to make the loan but as a homeowner that probably would not provide you with the peace of mind to know that the home you just purchased is worth the price you paid. It is possible, and I highly recommend it, that if the bank doesn’t require an appraisal that you as the purchaser should still get one so that you know the true value of what is typically your largest asset.

Agents Should Be Knowledgeable About New Trends

Whenever you are involved in a transaction like this it is important that when your agent writes up the contract they specify which appraisal the contingency is for. If the bank is getting a PIW or if they are using an AVM then a typical contingency would not cover this so you should specify that the contingency is for the appraisal that you order separately to help determine the true market value of the home.

Agents should be educated on these new products and methods that lenders and Fannie Mae are using to make loans. They should know how to specify within the contract which appraisal satisfies the contingency so that the best interests of their clients are protected.

Buyers should be aware of how the lender is financing their loan and whether a PIW, AVM, or traditional appraisal is being used. If you are not then it is possible for you to purchase a home that is worth less than you thought and you may not have any recourse with the lender or Fannie Mae in the future if you find out that your home is not worth what you paid.

The good thing about getting an appraisal for yourself is that you can choose your own appraiser and you don’t have to rely on the bank’s appraiser since they’re not using one. This can be a little confusing so let me explain.

The appraiser you choose is the one that will be providing YOU with an unbiased opinion of value. The bank will not be using it because they will be using their own methods such as the PIW or an AVM. Even though the bank will not use it, your appraisal can still be the one the contingency in the contract is based on. This way, if it does not appraise you will be able to get out of the contract.

With the introduction of new valuation and loan methods used by lenders and Fannie Mae come new strategies that buyers will need to use to make sure that their best interests are considered. Buyers will need to be more proactive in the loan process than they were in the past.

Questions?

Do you have any other questions about an appraisal contingency? Leave a comment below and as always, thanks for reading.

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Comments

  1. Great post Tom! The information you shared is so timely and important today, as you indicated. I really appreciate you point that the contract needs to specify which appraisal is being used as part of the contingency. Thanks for your great post! I always look forward to them.

    • Thanks, Jamie. I got the idea from listening to Phil Crawford and I thought it was important enough to write about. I think agents and buyers need to know what is going on and their options.

  2. From a seller’s perspective though…….. Another tool to potentially use to recoup an earnest money deposit rightfully due a seller for tying up the sale of a home from other potential buyers. I see the point of this in this instance without having an appraisal, but getting your own appraiser, it’s easy to persuade them to appraise low with a simple request. I just lost a sale to a buyer that wasn’t given proper scrutiny on their credit. I think more protections should be in place for sellers, not just buyers. A buyer has more than ample time to get the facts straight and do their due diligence with regards to buying. A seller is at the mercy of the games people play from overzealous to make a sale type real estate agents.

    • You bring up some good points. Sellers and buyers need to research the professionals they use whether it be an appraiser or a real estate agent. They should research the appraiser and get references to help prevent hiring a bad appraiser or one who would lowball the home. The agent should be able to qualify buyers based on their credit.

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