The Good & Bad of Financing and Appraisal Contingencies

The Good & Bad of Financing and Appraisal Contingencies

"You gotta know when to hold ‘em and know when to fold ‘em in the high-stakes world of real estate negotiations."

It’s not always the offered price of a home that catches a seller’s attention; it could also be how quickly a contract can move to the settlement table. Factors like contingencies – addenda that allow a contract to be voided under certain specified conditions – are an important consideration for both buyers and sellers. 

For most sellers, the fewer contingencies in an offer, the better. Every contingency comes with deadlines and terms that must be met and there’s potential for a contract to be delayed or derailed if the buyer doesn’t meet those terms. The reality of the current housing market is that many buyers are waiving their contingencies to appeal to a seller, including two of the most popular contingencies: Financing and Appraisal. But what happens when things go sideways and a buyer encounters trouble financing their loan or the home doesn’t appraise for the ratified contract sales price?

Brian Bonnet, SVP & Senior Loan Officer (NMLS ID 224811) for Atlantic Coast Mortgage, recently spoke with many of our Associates to run through different scenarios that buyers may encounter when using or waiving Financing and Appraisal Contingencies. While he noted that most of the contracts Atlantic Coast Mortgage is seeing have been ratified without a Financing or Appraisal contingency, there are situations where a qualified buyer should be hesitant to waive one or both of these contingencies.


What do these Contingencies do?

The Financing and Appraisal contingencies serve to protect a buyer during the real estate transaction. They are included in an offer that requires the buyer to “perform” according to the terms outlined in the contingency or risk defaulting on a ratified contract. If a buyer is not approved by the lender for their proposed financing, the Financing Contingency gives the buyer the option to cancel the contract without penalty (if they cancel within the terms of the appropriate Contingency Addendum). If a property’s appraised value – an amount that is determined by a licensed appraiser on behalf of the lending institution – doesn’t meet the contract sales price, a buyer has the option to void the contract if the seller doesn’t lower the contract sales price to the appraised value or doesn’t meet the lender’s standards required for the condition of the property.

These contingencies are available to conventional, FHA, and VA buyers while the latter two types of transactions may have additional restrictions on how they are used.


When might a Buyer waive the Financing Contingency?

If a buyer is considering waiving the Financing Contingency, beware of the pitfalls. “It is critically important that their financing is rock solid before they choose to remove that contingency,” Bonnet stressed. He recounted a recent experience with a buyer whose long-time work visa had expired and he therefore wasn’t able to continue at his current job until the visa had been renewed. Because the buyer had a Financing Contingency in place, the contract was voided. Had the contingency not been in place, the buyer could have been subject to losing their earnest money deposit (EMD) or other damages should the seller have elected to sue for defaulting on the contract. 

When a Financing Contingency is put in motion, the lender will begin a “canceled, withdrawn, or denied” process and an Adverse Action Letter, also called a Rejection Letter, outlining generic terms of why the financing was denied which is then sent immediately to all parties of the contract. This will be followed up by the buyer’s agent with the required paperwork to void the contract, release the buyer from further obligations, and allow the seller to put the property back on the market. 

A buyer may elect to waive this contingency if they are certain their employment is secure, are confident that their financial situation won’t change before settlement, or they are putting down a substantial downpayment that reduces the amount of their loan.


When might a Buyer waive the Appraisal Contingency?

An Appraisal is ordered by the lender to verify that a property is worth the amount of money that is being lent to purchase the property. For example, if a home is under contract for $500,000 the lender will want to see an appraisal value of $500,000 or greater. If there is an appraisal gap between the contract sales price and the appraised value, an Appraisal Contingency will spell out what happens next: the seller can agree to lower the sales price to the appraised value; the buyer and seller can renegotiate the sales price and the buyer can add additional cash to their offer to make up the difference; or the buyer can void the contract. In the absence of an Appraisal Contingency, the buyer is obligated to bring additional cash to make up the full difference in the appraisal gap.

A buyer may waive this contingency if they have a good cash reserve and can make up the difference without the cash outlay affecting the lending underwriting. Another scenario might be when a property is in an area where there is potential for value growth. Even if the appraisal comes in low, a buyer may elect to make up the cash difference because they are predicting that a property’s equity may grow quickly.


What can Buyers do?

  • Work with a respected, local lender who will advise buyers honestly and clearly on their individual financial risk. Local lenders have a better understanding of regional market dynamics and can speak to factors that can affect the transaction better than most national lenders who don’t have ready access to local information.
  • Ensure that when waiving an Appraisal Contingency, the contract specifies that an appraiser will still have access to the property. Many loans may not be approved without an appraisal, regardless of whether a buyer makes the appraisal a contingency to purchase.
  • Consider the condition of the home before waiving an Appraisal Contingency. Even if the market value of the home is determined to be adequate, a lender may not approve a property deemed uninhabitable. Bonnet notes that while the “vast majority of homes meet (habitability) standards, you don’t want to be the lone property that doesn’t.”

Overall, Bonnet advises borrowers to go into any real estate transaction with “eyes wide open to make an informed decision.” Enlist a respected, local lender and an experienced McEnearney | Middleburg Real Estate | Atoka Properties Associate to be the team that helps you land your next property!

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