Home Buying in San Ramon>Question Details

Mater, Home Buyer in Berkeley, CA

Difference between appraisal and loan contingencies

Asked by Mater, Berkeley, CA Sun Nov 1, 2009

I am trying to understand the difference between both. If there is an agreement to put 20% on a home with no appraisal contingency and if the bank estimates the home to be of much lower value would the situation not be covered by loan contingency (since bank may refuse to give the loan asked for)? What is the use of the appraisal contingency in cases where buyer only puts 20% down?

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This is a great question and one that can be more complicated than what you might expect.

The purpose of an appraisal contingency is to protect the buyer in the event that the bank does not appraise the property at a price that is at least equal to the sales price. If the property does not appraise, then the buyer has the option of canceling the agreement. In the real world, the buyer can and often will approach the seller about a price adjustment, which the seller is not obligated to accept. The buyer also has the option of bridging the shortfall with additional cash to make the deal work.

The loan contingency specifies that the contract is contingent upon the buyer being able to obtain the loan rate and terms as specified on the first page of the contract. It is not specifically tied to the appraisal. In your example, if the buyer is putting 20% down, but is still able to get the loan amount and terms specified even if the property did not appraise, they would be obligated to proceed (they might qualify for a 10% down loan at the same rate and terms). This is especially important in cases where the buyer is putting large amounts down (more than 35%).

Let's say the buyer waives the appraisal contingency. If the buyer, for example, is putting 50% down on a $1,000,000 purchase price, and the property only appraises for $900,000, the bank will probably still make the loan of $500,000 since they might only require 30% down, even though the house did not appraise at the sales price. The loan contingency is tied to the loan amount and the rate and terms, period. If the buyer is able to get the stated loan amount for the rate and terms specified, even if the property did not appraise, then the buyer is obligated to proceed. The fact that the property did not appraise is not a factor if there is no appraisal contingency. In this same example, if the buyer did have an appraisal contingency in the contract, they would not be obligated to proceed.

One other thing... before you remove your appraisal contingency, make sure the lender has completed an appraisal review if it is part of the bank's final approval. I have seen cases where buyers remove the appraisal contingency, only to find out the bank has reduced the appraised value as part of an appraisal review before they give final approval. As always, check with a good real estate attorney to discuss the details of your case specifically.


I hope that helps!

Doug Buenz
Web Reference: http://www.680homes.com/
0 votes Thank Flag Link Sun Nov 1, 2009
The two are interrelated but there is a sharp difference between them. What is implied by your post, I would characterize as loan contingency consideration. In other words it strength of buyer in regards to financing as explained in lenghty terms by Pacita.

Now the financing. Lets say we have a 400k loan and a buyer with 20% down payment of 100k on a 500k purchase. I use this beacuse I can do the math in my head easily. So buyer is in contract and the home appraises for 450k. Now like you descibe there is no problem with the loan approval. The buyer puts 90k down instead of 100k and you go to close right? Well no. A an appraisal contingency states that the contract is valid only if the property appraises for price on the contract. The buyer can now walk away. Right? Well no.

This is one way realtors make their money. Realtors make money by getting contracts to close. Our contracts state that the buyer just cant walk away. Buyers have to give the sellers a chance to reduce the sale price to the appriasal or get another appraisal (or lately go through an administrative appeals process which I wont get into here.)

Clearly the buyer isn't going to balk, they loved the house at 500k at 450k it would be assumed they are now extatic. Lets now say that the sellers pay for a 2nd appraisal and they lose the administraitve appeal. The value of the home is $450 per appriasal and there is an appraisal contingency and the contract says 20% down. The seller says, "I don't care, but I'll take 475k and I won't take a penny less."

Now, we know the buyer can offer the seller the additonal 10k (The difference between 20% of 500k vs 20% of 450k) without a problem. The loan contingency though says that the buyer can only put down 20%. There is a 15k gap. This is why there is a separate contingency for loan and appriasal.
Web Reference: http://bob2sell.com
2 votes Thank Flag Link Sun Nov 1, 2009
Mater,

I'm going to make a few assumptions in order to answer your questions.
1. You put an offer on a property and put 20% down, and the seller accepted. You are now in escrow.
2. You are getting a loan for the difference
3. Your contingencies include loan appraisal and loan approval
4. The property appraised for less than what you offered.

Here's a very simplistic description of the process

APPRAISAL CONTINGENCY
First, the bank sends an appraiser to investigate the value of the property.
The appraiser submits this information to the loan underwriter.
The underwriter looks at the appraisal to make sure the property meets certain guidelines (if the loan is FHA or VA, there are very strict requirements before a loan is granted)
Is the property appraised at the buyer's offer price?

LOAN APPROVAL
If the property meets the bank's requirements and if the property appraises at purchase price, then the loan is approved,
If the property is valued at less than what the bank is willing to loan, then this information is provided to the buyer ---- it will show what the bank is willing to lend. The bank will NOT approve a loan for higher than what the property appraises for after factoring in the down payment,

WHAT ARE YOUR OPTIONS?
1. You can present the appraisal to your seller and ask that the purchase price be reduced to the what the property appraised for
2. If the seller refuses, your options are: (a) cancel escrow and get your deposit back, assuming you haven't released your contingencies; (b) proceed with your escrow,, and come up, out of your pocket, with the difference between the offer price and the appraisal

AND....JUST BEFORE ESCROW CLOSES....
the process isn't finished yet. Right before escrow closes, the underwriter checks again to make sure the borrower is able to make the payments (is the borrower still employed? are the funds still in the buyer's accounts? has the buyer bought high-ticket items that affect his ability to make payments?

WHY HAVE AN APPRAISAL?
The use of the appraisal contingency is applied in many cases,even when there is no money put down as long as the buyer needs to get a loan. This is the bank's way of making sure that the property that the buyer is getting is worth the amount that they are buying. If the buyer defaults or if the property is foreclosed, the bank would want to see that they can get most if not all of the loan amount once the property is re-sold.

Hope this helps
1 vote Thank Flag Link Sun Nov 1, 2009
Very comprehensive answers. Pacita, Bob and Suzanne -- Thanks.
0 votes Thank Flag Link Sun Nov 1, 2009
Hi Mater,
The answer you were given below is accurate and detailed. She did an excellent job of explaining the process. The industry is trying to correct the new HVCC standards that were employed by Freddie Mac and Fannie Mae after the real estate downturn. Many of us have had transactions go south due to these processes. You should be able to get these questions answered by your realtor.
Good luck to you!
Suzanne Looker
0 votes Thank Flag Link Sun Nov 1, 2009
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