If you are active in the Oakland, Berkeley real estate market then you are aware we are in a seller's market and you have likely heard about all of the non-contingent offers. In a seller’s market there are typically multiple bids on a property. When a buyer writes a competitive offer in an attempt to win the bidding war there are three main contingencies to consider; the inspection contingency, loan contingency, and appraisal contingency. These contingencies are in place to protect the buyer, however, a buyer can choose to waive any or all in an effort to strengthen their offer and make it more appealing to the seller. I write many non-contingent offers for clients but I only do this when my clients have a thorough understanding of the risks and implications involved with writing and submitting a non-contingent offer.
When writing an offer with no contingencies, you are telling the seller that should you cancel, for any reason, you are aware that you are at risk of losing your earnest/initial deposit money.
Because the appraisal is an aspect of the escrow that is determined by a third party, I'd like to further address the appraisal contingency in more detail. Every house purchased with a loan has an appraisal performed. The hope is that the property appraises at the offer price. Sometimes, in a seller’s market, bidding wars can cause appraisals to come in lower than the purchase price. When an appraisal contingency is in place, an appraisal that comes in lower than the contracted purchase price allows the buyer the opportunity to potentially renegotiate the offer price with the seller. In contrast, if a buyer decides to waive the appraisal contingency, they have to be prepared to increase their down payment to cover the difference in the appraised value and their offer price.
Real World Example:
You are offering $900,000 on a home and it is your goal to buy a home with a 20% down-payment ($180,000 cash/$720,000 loan).
The appraiser comes out and appraises the home at $880,000. You have waived your appraisal contingency, so you will need to have funds to cover the 20% down-payment, of the appraisal price ($176,000) plus an additional $20,000. See below:
$176,000 adjusted down-payment based upon 20% of the appraisal value +
$20,000 additional down-payment +
$704,000 adjusted loan amount = $900,000
Why do the numbers change? A 20% down-payment loan program is based upon the appraised value, not the offer price. The seller accepted your offer at $900,000 and you wrote your offer saying you would pay $900,000, even if it does not appraise at this price.
What is at stake if you take a risk and do not have the funds to cover the difference? Your earnest money, also known as a good faith deposit. Typically, in our niche market, buyers are placing 3% of their offer price in a neutral escrow account. This money is held there until the escrow officer has mutual instructions from both the buyer's agent and seller's agent. This 3% is applied to the buyer's down-payment, unless the buyer breaches their contract. "Breach" means backing out for a reason outside of your contingencies or reasons not permissible per the contract. So, if you write an offer with no contingencies, which many buyers are now doing, and you back out because an appraiser values your potential future home for less than you offer, this is considered a breach of contract.
I hope this explanation helps you better understand the risks and implications of offers written without contingencies - specifically, an appraisal contingency.