I sometimes get asked about waiving one or all contingencies in a real estate contract, to help make for a more aggressive offer in a competitive sellers’ market. The main contingencies in most real estate contracts are the appraisal contingency, the financing contingency, the termite inspection contingency, and the home inspection contingency. I am not a proponent or an opponent of any of these strategies, but simply want to discuss the pros and cons of each, since it is a question I do get. Let me take these one at a time.
The appraisal contingency can be inconsequential if you either have a large down payment or have a lot of cash. If you are doing a 30% down conventional loan, for example, you have room for appraisal error. If your home goes under contract for $500,000 and you plan to borrow $350,000 (or 70% of the sales price, after a 30% down payment), and if the appraisal comes in a bit low at $490,000, then you have a $350,000 loan against a $490,000 appraisal, or a 71.43% loan-to-value (LTV). If the maximum LTV on your loan is 80%, chances are you still have not exceeded the maximum LTV for the loan program so your loan approval will not be in danger due to the LTV, and you will have made a more aggressive offer by waiving your appraisal contingency.
However, if you have the same scenario but with a 10% down payment on a $500,000 sales price, which is a $450,000 conventional loan amount, and you end up with a $490,000 appraisal, now there is a problem. The LTV is now 91.84% due to the lower appraisal, and on a $450,000 loan amount the maximum LTV is typically 90% on a conventional loan. Now you have to either negotiate with the seller to drop the sales price to $490,000 and then take your 90% loan on that amount (which the seller won’t do if you waive the appraisal contingency), or you have to make up the difference in cash by taking a 90% loan on the $490,000 appraisal and paying the $10,000 in cash to get the seller the $500,000 you agreed upon. Without an appraisal contingency, you cannot negotiate a solution with the seller. The figures used here are hypothetical. Guidelines vary based on borrowers specific loan scenario and loan program used.
In the next blog, I’ll discuss the pros and cons of waiving your financing contingency.