A home appraisal is an independent appraisers’ opinion of the current market value of your home. Most home purchases in the Northern Virginia area are contingent on an appraisal – particularly if the home has a financing contingency.
For the lender the purpose of the appraisal is to make sure the price paid for a home is at or above the market price. Usually, the lender’s sole remedy in case of a mortgage default is the home itself. It is therefore important for the lender to make sure there is sufficient equity in the home to cover their loss if there is a default.
So, what would happen if you have a ratified contract to purchase a home and the appraisal came in lower than the agreed to purchase price?
Well, the answer would be the NVAR regional sales contract. The pertinent appraisal section of the Northern Virginia Association of Realtors sales contract is as follows:
APPRAISAL CONTINGENCY This Contract __ is contingent OR __ is not contingent upon an Appraisal pursuant to this paragraph. Purchaser shall have until 9 p.m. 21 Days (minimum of 21 days recommended) following the Date of Ratification to obtain an Appraisal (“Appraisal Deadline”). In the event that neither box is checked, this Contract is contingent upon an Appraisal pursuant to this paragraph and the Appraisal Deadline is the Financing Deadline set forth above. Purchaser shall provide Notice to Seller by the Appraisal Deadline, as follows:
A. The Appraisal is equal to or greater than the Sales Price. This contingency has been satisfied and removed. The parties shall proceed to Settlement; OR
B. The Appraisal is equal to or greater than the Sales Price. However, Purchaser elects not to proceed with consummation of this Contract because the Property does not satisfy the lender(s) requirements, the Appraisal does not allow for the Specified Financing or the Property is inadequate collateral. Such Notice must be accompanied by a written denial of the financing showing written evidence of the lender(s)’s decision concerning the Property. Purchaser must provide such written evidence concurrently with Purchaser’s Notice of election not to proceed; OR
C. The Appraisal is not equal to or greater than the Sales Price and Purchaser elects not to proceed with consummation of this Contract unless Seller elects to lower the Sales Price to the appraised value. Purchaser’s Notice shall include a copy of the written statement setting forth the appraised value of the Property. It will be Seller’s option to lower the Sales Price to the appraised value and the parties shall proceed to Settlement at the lower Sales Price. If Seller does not make this election, the parties may agree to mutually acceptable terms. Each election must be made by Notice within 3 Days after Notice from the other party. The parties will immediately sign any appropriate amendments. If the parties fail to agree, this Contract will become void; OR
D. Purchaser elects to proceed with consummation of this Contract without regard to the Appraisal. The parties shall proceed to Settlement.
If Purchaser fails to give Seller Notice by the Appraisal Deadline, this contingency will continue, unless Seller at Seller’s option gives Notice to Purchaser that this Contract will become void. If Seller delivers such Notice, this Contract will become void at 9 p.m. on the third day following Delivery of Seller’s Notice, unless prior to such date and time Purchaser delivers the required Notice.
So, quite a handful there… Assuming the purchaser has the appraisal contingency checked and the appraisal comes in low, the purchaser has the following options:
- Try to negotiate the price down
The possibility of finding mutual terms will vary a lot on the strength of the real estate market, and the motivation of each side. Furthermore a party may or may not have the ability to reduce the price or to pay cash above the appraised value. If the sides can not agree the contract will become void.
- Proceed with the purchase regardless of the appraisal
In this case the purchaser would need to bring extra money to the closing for the difference. The lender will only use the appraised value as a basis for the loan.
Example: With a $800,000 purchase price, 80% financing and a $750,000 appraised value how much would that be? With an appraisal at $800,000(or higher) the purchaser would need a $160,000 down payment. With a $750,000 appraisal instead of bringing $160,000 as a down payment the purchaser would now need $210,000 as a down payment. That is $50,000 extra cash needed.
- Challenge the appraisal
Sometimes the appraiser will make a mistake – in such a case the appraisal can be challenged and a revised appraisal value be the result. It is not common but sometimes an argument can be made for obvious mistakes on square footage, number of legal bedrooms etc.
In the case of a low appraisal the buyer and seller will usually work out a solution. The closer the appraised value is to the purchase price the better the chance of things being resolved. Sometimes the seller cannot sell below a certain price (they have no money and their mortgage is close to the sales price.) or the purchaser may not have any extra money beyond what is needed for the original down payment and closing cost. In those cases everyone goes their own way.