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Waiving Appraisal Contingency is Risky Business

Written by on Monday, 15 April 2013 7:00 pm

In many parts of the country the market is hot and prices have come roaring back. This presents a problem for appraisers, and, therefore, it presents a problem for buyers who, typically, have a contingency (often as part of a loan approval contingency) that the property must appraise for at least the contract price. In many areas, sellers are insisting that buyers must waive any appraisal contingency. Often, buyers are willing to do this; but certainly risks are involved.

The problem is not uniquely new. Many agents have experienced this sort of market phenomenon before. On the one hand, there is excess demand; thus, prices rise. On the other hand, lenders continue to be cautious, and appraisers are not only cautious, but also are bound by data that is more reflective of what has happened than what is happening now. As a result, it is not uncommon for appraisals to come in at a lower price than the one that was agreed to by buyer and seller. What happens then? If the appraisal contingency has been waived, the scenario may go something like this:

The agreed-upon price is $400,000. The buyer proposes to obtain an 80% loan ($320,000) and to put 20% down ($80,000). But, at the seller's insistence, the buyer waives any appraisal contingency. If the property appraises at less than $400,000, he will make up the difference.

Suppose, then, that the property appraises for $380,000. The lender, who is willing to put up 80% of appraised value, is now going to give a loan of $304,000. Normally, that would kill the deal, but, if the buyer has waived the appraisal contingency, he will have to come up with $96,000 down, rather than $80,000.

Of course the appraisal might have been even lower. That would require the buyer to put down even more money. One strategy that buyers can try in these situations is to put a cap on how much they might have to come up with. For example, a buyer might say, "If the property doesn't appraise, I will come up with the difference up to a certain amount, $xxx. If more is required, the seller will have to reduce the price proportionately." Naturally, depending on the seller's perception of the market, such a strategy may or may not be acceptable.

Sometimes buyers are told something like this: "Don't worry about waiving the appraisal contingency, you can always get out of the transaction on the basis of some other contingency [usually inspections]." Real estate agents ought never to say this. For one thing, by common law, contracts - such as real estate contracts - have an implicit covenant of good faith and fair dealing. Sometimes, as in the contract produced by the California Association of Realtors® (CAR), this covenant is made specific. You can't just make up some reason for getting out.

Also, there are timing issues. The speed at which appraisals occur and are completed is notoriously difficult to predict. Regrettably, it is common for the appraisal to occur relatively late in the transaction period. Now, in California for example, the inspection period is usually seventeen days (it can be changed by mutual agreement). It would not be at all unusual for the appraisal to occur after that period had run. Which is to say, by the time the appraisal comes in, it will probably be too late to get out of the contract on the basis of an alleged inspection deficiency.

A buyer's agent in a no-appraisal-contingency is in a dicey position. Buyers want what they want and will pay what they are willing to pay. But they look to their agents for guidance. While I, personally, don't think we are in a bubble about to pop, we could be. And among those buyers who agreed to pay over appraised value, some are liable to be aggrieved. Hard as it is to believe, some might come back after their agents.

CAR produces a form entitled "Market Conditions Advisory" (MCA). Among other things, the form specifies that a purchase price offered by a buyer is his decision, not the agent's. Moreover, it states that making an offer without contingencies, such as the appraisal contingency, is not recommended by the broker. The MCA was a product of the bubble years. It is becoming relevant again. Especially if buyers are willing to waive appraisal contingencies.

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  About the author, Bob Hunt

Individual news stories are based upon the opinions of the writer and does not reflect the opinion of Realty Times.