An appraisal contingency and the results from waiving that contingency are often misunderstood. A lot of buyers and sellers gloss over the appraisal requirement in their contract to their detriment.
If a buyer is getting a mortgage loan to purchase a property, the contract likely contains a condition that their lender must approve an appraisal of the property. The approval of an appraisal is contained in the Third Party Financing Addendum. This financing addendum states that if the buyer cannot secure their financing within a certain number of days, then they can get out of the contract.
What most folks miss is that this addendum also states that if the property doesn’t meet lender requirements (including the appraisal), then the buyer can terminate the contract.
Appraisal Termination Waiver
To circumvent this appraisal contingency, some buyers and sellers use an addendum called the “Addendum Concerning Right to Terminate Due to Lender’s Appraisal.”
They often think this means an appraisal doesn’t affect the purchase. That would be wrong.
This addendum basically states that the buyer waives their right to terminate the contract if the appraisal does not meet the lender’s requirements. Rather than a waiver of appraisal, this form is more of a waiver of the loan amount that their lender is willing to make. If the appraisal comes in low, then the buyer would need to make a higher cash down payment.
The “appraisal waiver” addendum does not bind the buyer to pay a certain amount above the appraised value. The buyer will still pay the sales price on the contract. This addendum only affects the loan amount. The buyer will need to make up the difference between any reduced loan amount and the purchase price.
For example, let’s use an example of a house listed for $450,000. The buyer really wants it, and contracts to pay $500,000. The contract says the buyer’s cash down payment is $50,000 and the buyer’s loan amount is $450,000.
This is what their lender will loan them — basically a 90 percent loan. The lender cares about the percentage of the property’s value that the buyer is financing, not the actual sales price.
Let’s say the property appraises for $450,000. Remember that the lender is giving this buyer a loan for 90 percent of the sales price or value. That amount is now $405,000 (90 percent of the appraised value). The buyer is going to need to come up with a $95,000 cash down payment.
So, you see, the appraisal impacts the loan amount, not the sale’s price. Instead of using the appraisal waiver addendum, why wouldn’t the buyer just write their $500,000 offer with a higher down payment?
Can The Buyer Still Afford It?
Some buyers use this appraisal waiver as an appealing tool in their negotiations. Sellers need to keep in mind that a buyer making a generous offer — perhaps over list price — might not be better than a more solid buyer at a lesser price. Has the seller verified that the buyer has the additional cash in a worse-case scenario? Does this buyer have the financial means to close the deal?
A high offer looks great. But if it doesn’t close, what good is it?
Some real estate attorneys advise buyers and sellers to avoid using the appraisal addendum. Instead, they should adjust the cash down payment and loan amount on the contract.
The opinions expressed are of the individual author for informational purposes only and not for legal or financial advice. Contact an attorney or accountant for any particular issue or problem.
