An appraiser uses market and other data to provide an opinion of the market value of a property. Appraisals are extremely useful and the opinion of appraisers are valued for many reasons. Lenders use appraisals to feel assured that, if the borrower does not pay the loan, the property has enough value for the Lender to foreclose, sell the property, and pay off the loan.
Mortgage loans therefore generally do not exceed a maximum % of the lower of:
- a) the purchase price, or;
- b) appraised value.
Many Buyers want to include language in their Contract stating: “If the appraised value is less than the purchase price then the parties agree to renegotiate the purchase price or Buyer may cancel the contract.” This means that even if the bank is willing to make the loan, if the appraised value of the home is lower than the purchase price, the Buyer is entitled to a price reduction.
This can be a problem. Appraisal values are generally based on sales of similar properties in the recent past. So when prices are rising rapidly in the market, the agreed to purchase price may be higher than the appraisal value. Essentially, “appraisal contingencies” give an appraiser – who is not buying the house in today’s market and who must be conservative to protect the bank – rather than the Buyer the final say on price.
If a Buyer’s down payment is sufficiently high, it is entirely possible that the bank will approve a mortgage loan even if the house appraises lower that the purchase price.
Appraisal contingencies create uncertainty for everyone and they are not reflective of the market. Sellers don’t want these clauses because of the uncertainty. Buyers can lose deals to other Buyers who do not insist on this contingency. As such we do not recommend that Sellers or Buyers use this clause – you didn’t make the deal with the appraiser, you made it with the each other.