I sometimes get asked about waiving one or all contingencies in a real estate contract. This helps 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. I 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
The appraisal contingency can be inconsequential if you either have a large down payment or have a lot of cash. For example, if you are doing a 30% down conventional loan you have room for appraisal error. If your home goes under contract for $500,000 and you plan to borrow $350,000 that is 70% of the sales price after a 30% down payment. And if the appraisal comes in a bit low at $490,000 you’d have a $350,000 loan against a $490,000 appraisal. This is a 71.43% loan-to-value (LTV). With the maximum LTV on your loan at 80% to still avoid Private Mortgage Insurance, 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.
When is it a problem
However, assume you have the same scenario but with a 10% down payment. That means a $500,000 sales price and a $450,000 conventional loan amount. If 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 lower value. And in this case the seller won’t do that if you waived 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.