Real Estate Investing

What to Know About Appraisals and Appraisal Contingencies  

March 26, 2024

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Appraisals and Appraisal Contingencies

Are you buying or selling a home? Knowing about appraisals and appraisal contingencies can save you from costly surprises. 

In this article, we’ll explain the importance of appraisals in real estate and how they determine property value. 

You’ll also learn about property appraisal contingencies and the benefits of including them in your real estate transactions. 

By navigating the appraisal process successfully, you’ll be better equipped to make informed decisions and protect your investment.  

Importance of Property Appraisal in Real Estate 

Why are appraisals important in real estate? 

Appraisals play a crucial role in the real estate industry as they determine the fair market value of a property. Whether you’re buying or selling a property, an appraisal helps ensure that the price is fair and accurate. 

For buyers, appraisals provide reassurance that they aren’t overpaying for a property. On the other hand, sellers benefit from appraisals by ensuring that they’re listing their property at a reasonable price to attract potential buyers. 

Additionally, appraisals are often required by a buyer’s mortgage lender (or by the seller in the case of seller financing) to determine the mortgage loan amount they’re willing to provide. 

How Appraisals Determine Property Value 

To determine a property’s value, appraisals use a variety of factors and methods. Appraisers consider factors such as the property’s location, size, condition, and amenities. They also analyze market trends, recent sales data, and comparable properties in the area. By examining these factors, appraisers aim to provide an unbiased estimate of the property’s worth. 

There are several different methods for calculating a home appraisal. An appraiser may employ the sales comparison approach, where they compare the property to similar ones that have recently sold. Alternatively, they may use the cost approach, which calculates the value by determining the cost of rebuilding the property. The income approach is used for commercial properties and considers the potential income the property could generate. 

Ultimately, the goal of a property appraisal is to provide an accurate and fair assessment of a property’s value, called the appraised value. 

Understanding Appraisal Contingencies 

An appraisal contingency is a clause in a real estate contract that allows the buyer to back out of the deal if the property doesn’t appraise for the agreed-upon purchase price. For instance, if there is an appraisal gap, or a difference between the appraised fair market value and the agreed-upon price, the buyer and seller may need to re-negotiate the sale. 

Appraisal contingencies work by protecting the buyer from overpaying for a property and ensuring that the lender won’t provide a loan for more than the property is worth. 

If the property doesn’t appraise for the agreed-upon price, the buyer can renegotiate with the seller, request that the seller lower the price, or terminate the contract altogether. The buyer may also get their earnest money deposit refunded if they put earnest money down. Buyers should ensure that their purchase contract includes an appraisal contingency clause in case such renegotiations are necessary. 

Either the buyer or seller may write other contingency clauses into the agreement as well. For instance, buyers commonly request a financing contingency, which gives the buyer the right to back out of the deal if they fail to secure financing for the property. 

Understanding appraisal contingencies and other contingency clauses is essential for both buyers and sellers to ensure a smooth and successful real estate transaction. 

Appraisal Contingency Example 

Imagine that Buyer Bob enters a purchase agreement with Seller Sam. Bob puts an offer in for the house slightly over the asking price, $238,000. This price is consistent with other homes of similar size in the local housing market. Happy with this offer, Sam takes his home off the market and begins negotiations with Bob’s team. 

Bob is a meticulous buyer and knows that appraisal contingencies protect him in case of a low appraisal. When he and his real estate agent review the contract, they propose an appraisal contingency. Sam agrees. 

Everything seems to be going well, but then the appraisal determines that Sam’s home is only worth $190,000. Sam’s asking price was too high for the appraised value of the home, and now Bob isn’t sure he wants to go through with the sale. Because Bob and Sam’s contract has an appraisal contingency, Bob can legally back out of the sale without consequence. 

Benefits of Including an Appraisal Contingency in Your Contract 

Including appraisal contingencies in a real estate contract allows you to protect your investment and avoid potential financial risks. By including an appraisal contingency, you’re essentially making the purchase of the property contingent upon the appraisal value meeting or exceeding the agreed-upon purchase price. This provides you with an opportunity to renegotiate the price or even back out of the deal if the appraisal comes in lower than expected. 

This can be especially beneficial in a competitive real estate market where prices may be inflated. An appraisal contingency can help you avoid overpaying for a property and ensure that you’re making a sound financial decision. It gives you peace of mind knowing that you have a safety net in place to protect your investment. 

Navigating the Appraisal Process Successfully 

Successfully navigating the appraisal process as a seller requires thorough preparation and understanding of the factors that can impact the appraised value of a property. 

To begin, ensure that your property is in good condition and well-maintained. Address any necessary repairs or upgrades before the appraisal to maximize its value. 

It’s also important to research and provide the appraiser with relevant information about recent sales of similar properties in the area. This will help establish a fair and accurate appraisal value. 

During the appraisal, be present to answer any questions the appraiser may have and provide additional information about the property. 

After the appraisal, carefully review the report to ensure its accuracy. If you find any errors or discrepancies, address them promptly with the appraiser and/or your real estate agent. 

Conclusion 

When it comes to buying or selling a property, appraisals and appraisal contingencies play a crucial role. Appraisals help determine the value of a property, ensuring a fair transaction for both parties. 

Including appraisal contingencies in a real estate contract provides protection for buyers, allowing them to back out or renegotiate if the appraisal comes in lower than expected. 

Understanding and navigating the appraisal process successfully can save both time and money, making it a vital step in any real estate transaction. 

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