The Appraisal Contingency

Why it’s a good thing

The appraisal of a property’s value has become a regularly used residual service by homebuyers in the real estate process. However, it can become a tool that is tossed by the wayside in a hot market — and that’s not very wise when it comes to the largest investment most consumers will ever make.

The appraisal serves various purposes in a transaction for several people. It acts as a financial compass, as it were, for everyone that has a monetary stake in the property value — the seller, the buyer, the lender, and the insurance company.

If you’re looking to use mortgage financing, it’s hard to overlook an appraisal. Now, many buyers, trying to compete with other purchasers, may waive the appraisal contingency, but they will still have to have an appraisal to get financing. It just means that once the appraisal is completed, regardless of the final number, they will still walk toward the closing table. In my humble opinion, this is like handing over a blank check to the seller and telling him to just write whatever he wants for the house and empty your bank account.

Don’t throw caution to the wind

Why would you write a contract on a house for $440,000 when a professional appraiser warrants that it’s only worth $425,000? I’ve never met anyone who would buy a car or invest in stock in such a manner, but they’ll throw all caution to the wind in the field of real estate. It’s become so prevalent in some markets that Realtors even have a disclaimer form that they provide for buyers saying they have been informed of the dangers of waiving the appraisal — and yet, buyers will sign it and move along.

The scenario usually works something like this — a house is placed on the market at $400,000 and several offers come in immediately. Two require an appraisal, the third, offering $420,000, does not, so the seller goes with it. In addition, the contract has a $40,000 earnest money deposit. The lender requires an appraisal before they will lend $380,000 to purchase the house, and it comes in at only $400,000 — revealing a $20,000 gap between the contract price and the value (and $20,000 more than what the lender is willing to provide to purchase the property).

Now, keep in mind, an earnest money deposit is not the same as a down payment, though it can be merged into the transaction as down payment money once the contract is ratified. The earnest money deposit is submitted to the seller as a means of saying, “We’re really serious about buying this house.” If the transaction goes south, however, the seller could demand to keep either a portion or all of the deposit if the buyer can’t perform the contract.

Danger, danger!

That’s why waiving the appraisal is a dangerous way to buy a house. If all goes well, then nothing bad happens. The buyer gets the house and thinks all this disclaimer stuff and warnings are from a bunch of nervous real estate agents who don’t like to take risks.

But why don’t you ask the buyer who exercised this type of offer that went sour? They lost half of their earnest money because the appraisal didn’t come in high enough for them to even get the financing and the seller demanded the earnest money deposit to pay for the lost marketing time and the money he now has to put out for more payments, insurance, etc., to put it back on the market because the buyer wrote a contract he can’t fulfill.

The result is either a lawsuit (and we’re not talking small claims court); trying to renegotiate the sales price (good luck); moving forward by finding even more money to pay for the inflated price agreed upon (which is usually what happens); or taking the hit on your earnest money deposit and finding another house — except, now, with less money in your pocket than what you had before.

If you wouldn’t buy a business or invest in stock without determining the true value of the object of your purchase — why would you purchase a house in such a manner? It doesn’t make sense and it can cost you tens of thousands of dollars if your strategy fails. The road to homeownership is strewn with the carnage of unwise strategies — throwing away the appraisal is one of them.

M. Anthony Carr  has covered real estate for more than 15 years and is the author of “Real Estate Investing Made Simple.”