Ask Adam: To Waive or Not to Waive

This regularly-scheduled sponsored Q&A column is written by Adam Gallegos of Arlington-based real estate firm Arbour Realty, voted one of Arlington Magazine’s Best Realtors of 2013. Please submit follow-up questions in the comments section or via email.

Question: I’m planning to purchase a home in Arlington this spring and have heard stories about how crazy the market is getting. I’ve read about people waiving their appraisal contingency in markets like this. Can you explain how that works?

It’s important to first understand why someone would consider this strategy… residential appraisers primarily employ the sales comparison approach to determining a home’s value. This method is heavily reliant on past comparable sales. In situations where a home may sell for more than the recent sales prices of comparable homes (i.e. due to competition from multiple offers), the property may appraise for less than the agreed upon sales price.

If an appraisal comes in low, we usually use it as leverage to try and negotiate a lower sales price. It isn’t exactly fair to the seller because they agreed to a higher price at the onset, but sometimes it is necessary for a buyer to be able to continue with the purchase. Therefore, you can see how waiving the appraisal contingency up front would strengthen an offer by relieving the seller of having to worry about whether a contract they are considering will appraise for the agreed upon purchase price or not.

From a purchaser’s perspective, waiving the appraisal contingency could result in a situation that requires more funds than initially expected, change the loan terms (i.e. monthly payments could be more expensive) or even cause the contract to be in default if the purchaser is unable to proceed with the purchase.

Based on the loan program you use, the lender will require a minimum amount of equity on your part. In turn, they are only willing to finance the balance of that equity. For instance, if your loan requires a minimum of 20% owner equity, it will lend up to 80% of the lower between purchase price or appraisal value. If you are stretching financially to meet the minimum requirement of your loan program then waiving the appraisal contingency is not an option for you.

If you are putting down a lot more money than is required by your loan program, then waiving all or a portion of the appraisal, contingency may be an option, one you could consider very carefully. In this situation it might affect your down-payment or monthly payments. However, it eliminates your leverage to try and negotiate a lower purchase price if the appraisal comes in low.

Below is a simplified example of how this works:

For a purchase price of $500,000, you are planning on a $200,000 down-payment and a $300,000 loan. You are obtaining a loan that requires 20% equity, therefore the loan program is willing to lend 80% of the lesser: appraisal or purchase value. With a $200,000 down-payment and $300,000 loan, as long as the home appraises for more than $375,000 your down-payment and monthly payments will not be affected.

On a $500,000 purchase, I’m hoping you are confident that it will appraise well in excess of that minimum threshold. For the sake of this example, let’s say it only appraises for $350,000. In this situation, you will need to increase your down-payment to $225,000 and instead of borrowing $300,000 as originally planned, you will now be borrowing $275,000.

This example assumes you have the financial ability to increase your down-payment if needed. If not, you may have to consider a less desirable loan program and if there is not one available, you could be facing default.

If you are thinking about waiving your appraisal, it is important to understand the worst case scenarios. Talk over your situation in detail with your lender and real estate agent. Please be clear that I am not encouraging you to employ this strategy. In fact, I am cautioning that it should be considered an advanced technique that should be used with extreme care.

The views and opinions expressed in the column are those of the author and do not necessarily reflect the views of ARLnow.com.