“Appraisal” doesn’t mean “Approval” anymore.
February 19, 2010
Contingencies are key checkpoints that are inserted into the Residential Purchase Contract to protect the buyer …or more specifically, the buyer's deposit, in the event that something happens outside of the buyer's control that prevents the sale from proceeding. And that's important, because customarily the good faith deposit that the buyer submits with the offer is usually 3% of the purchase price — that's no small chunk of change on any home in San Carlos!
The most common contingencies that buyers invoke are usually Title, Property Condition, and Finance. The information needed to remove Title and Property Inspection can be obtained in relatively short order — title reports are readily available, and property inspections are usually completed in a matter of days (if you have a good inspector.)
The Final Checkpoint
So that leaves us with the Finance Contingency. Because it typically takes the lender longer to gather the information that they need to approve the loan to fund this purchase, the Finance Contingency is usually the last one to be removed, and consequently the last “safety net” for your hefty deposit check. You'll notice that a good buyer's agent will always request a longer removal period for this contingency than all of the others.
So what is a Finance Contingency? The PRDS Residential Purchase Contract defines it as:
“…this contract is made contingent on Buyer's obtaining a loan commitment for the financing described in Paragraphs 1D and/or 1E, and shall have ___ days from Acceptance within which to remove or otherwise act on said contingency. (Buyer agrees to verify all loan terms directly with Lender prior to removing this contingency.)”
The most important sentence in this entire contingency is the last one. Here's why…
It Ain't Over ‘Til It's Over..
When you are “pre-approved” for a loan, you do most of the work with the bank up front, prior to making an offer on a home. Consequently, when you get a pre-approval letter from the bank and you're ready to go shopping, there are only a few conditions attached this approval — the biggest of which is that the bank requires a satisfactory appraisal which justifies the purchase amount. This is where things get tricky…
Up until recently, if your prospective home appraised at the sales price (or high enough to get the loan you committed to), you were done. It was safe at that point to remove the Finance Contingency, because the loan approval was a rubber stamp after that. But that's not the case anymore.
Lenders can no longer conduct their own appraisals — new laws require them to outsource this key function to Appraisal Management Companies that are not affiliated with the bank. This means the bank will usually have their underwriters scrutinize the appraisal once they get it back from the AMC, even if the appraisal justifies the offer price. If that underwriter finds anything amiss in the appraisal — i.e. not enough comparable homes, inconsistent remarks, or they outright challenge the valuation — it can get kicked back for further review and possible re-appraisal. Thankfully this only happens in a minority of the cases, but it is happening with increasing frequency.
But this serves as a perfect reminder that your loan isn't approved when the appraisal is completed — your loan is approved when the lender tells you they have approved your loan. (Did you notice that the word “appraisal” isn't even in the definition of the Finance Contingency?)
In other words, it ain't over til it's over.
For buyers, the Finance Contingency is often the last checkpoint to protect your deposit check. You can see the pickle you can get yourself into if you rush to remove your Finance Contingency as soon as you hear that the home appraised at your offer price. In today's market, wait an extra day or so until the lender approves the entire loan package (including the appraisal) and is ready to issue loan documents to the title company before you remove that last safeguard. Don't be pressured into doing it sooner simply because your contingency removal deadline is approaching. A good agent will first ask for an extension of the deadline in advance of the deadline of this contingency if he or she senses that there could be a delay — any reasonable seller will usually grant this, since the delay is out of the buyer's control.