Understanding Financing Contingency vs Appraisal Contingency in Real Estate

Whether you're representing the buyer or the seller, you want the best for your client. That's what makes you a great real estate agent. There can be a few tricky contingencies along the way that you need to be aware of in order to navigate a smooth closing. Let's take a closer look at two of these important contingencies: financing contingency and appraisal contingency.

What is a Financing Contingency?

A financing contingency is a clause in a real estate purchase contract that protects the buyer's earnest money deposit if they are unable to secure financing for the property. It provides an opportunity for the buyer to back out of the contract without any financial penalty if they are unable to obtain a mortgage loan.

How does a financing contingency work?

When a buyer includes a financing contingency in their offer, it means that the purchase of the property is contingent upon their ability to secure financing. If the buyer is unable to obtain a mortgage loan within a specified time frame, typically 30-45 days, they can choose to terminate the contract and have their earnest money deposit returned.

Who needs a financing contingency?

A financing contingency is beneficial for any buyer who is relying on a mortgage loan to finance their home purchase. It provides an extra layer of protection in case the buyer is unable to secure financing.

Do sellers like financing contingencies?

Sellers may have mixed feelings about financing contingencies. On one hand, they want to sell their property as quickly as possible and may prefer offers from buyers who are already pre-approved for a mortgage. On the other hand, a financing contingency can protect the buyer and ensure that the transaction is not jeopardized if they are unable to secure financing.

How do financing contingencies compare to other contingencies?

Financing contingencies are just one type of contingency that can be included in a real estate purchase contract. Other common contingencies include appraisal contingencies, home inspection contingencies, and clear title contingencies. Each contingency serves a specific purpose and protects the interests of either the buyer or the seller.

What is an Appraisal Contingency?

An appraisal contingency is a clause in a real estate purchase contract that protects the buyer's interests if the property does not appraise for the agreed-upon purchase price. It allows the buyer to renegotiate the terms of the contract or terminate the agreement if the appraisal comes in lower than expected.

How does an appraisal contingency work?

When an appraisal contingency is included in a purchase contract, it means that the buyer has the right to have the property appraised by a licensed appraiser. If the appraisal value comes in lower than the agreed-upon purchase price, the buyer can choose to renegotiate the price with the seller or terminate the contract and have their earnest money deposit returned.

Pros & Cons of Financing and Appraisal Contingencies

Both financing and appraisal contingencies have their pros and cons for both buyers and sellers. Let's take a closer look at the advantages and disadvantages of each:

Advantages of Financing Contingencies:

• Protection for the buyer's earnest money deposit
• Allows the buyer to back out of the contract if they are unable to secure financing
• Gives the buyer time to shop around for the best mortgage rate and terms

Disadvantages of Financing Contingencies:

• May make the buyer's offer less competitive in a competitive market
• Can delay the closing process if the buyer encounters financing issues
• Sellers may prefer offers without financing contingencies

Advantages of Appraisal Contingencies:

• Protects the buyer from overpaying for a property that does not appraise at the agreed-upon price
• Gives the buyer an opportunity to renegotiate the price with the seller
• Ensures that the buyer is not stuck with a property that is worth less than they paid for it

Disadvantages of Appraisal Contingencies:

• May delay the closing process if the appraisal comes in lower than expected
• Sellers may be unwilling to lower the price or renegotiate the terms of the contract
• Can lead to a terminated contract if the buyer and seller cannot reach an agreement

When Should a Buyer Waive the Financing Contingency?

Waiving the financing contingency can make a buyer's offer more competitive in a hot real estate market. However, it is a risky move that should only be considered in certain situations:

• The buyer has a strong pre-approval from a reputable lender
• The buyer has enough cash reserves to cover the purchase price if the financing falls through
• The buyer is confident that they can secure alternative financing if their initial loan application is denied

When Should a Buyer Waive the Appraisal Contingency?

Waiving the appraisal contingency is also a risky move that should only be done under certain circumstances:

• The buyer is confident that the property will appraise at or above the agreed-upon purchase price
• The buyer is willing to risk overpaying for the property
• The buyer has enough cash reserves to cover the difference if the appraisal comes in lower than expected

Conclusion

Financing and appraisal contingencies are important clauses in a real estate purchase contract that protect the interests of both buyers and sellers. While financing contingencies provide a safety net for buyers who rely on mortgage financing, appraisal contingencies ensure that buyers do not overpay for a property that does not appraise at the agreed-upon price. It's important for both buyers and sellers to understand these contingencies and weigh the pros and cons before entering into a real estate transaction.