With a seller's market like it is right now in the Spring of 2021, many of my clients have used appraisal clauses on their offers in order to help them get their offer accepted in a multiple offer situation. For that reason, I get asked all of the time to explain how an appraisal clause works. So I wanted to spend a few minutes explaining the basic details about appraisal clauses and how they work.
In order to understand the appraisal clause, we have to start with the appraisal. This is the valuation that is conducted by an independent appraiser and is the value of the home which will then be used by your lender for determining the amount of a mortgage that they will provide to you. In a standard offer, if the appraised value is lower than your offer price, then their are two options. The first is that your agent can negotiate with the seller's agent for a lower price that either meets the appraised value or at least comes closer to it. The other option is that you will have to make up the difference in the appraised price and your offer price by bringing more money to the closing table. This will also be the case if you negotiate a lower price if it is still higher than the appraised value. Remember that your lender will not base your mortgage value on anything greater than the appraised value of the home.
How does an appraisal clause work?
In a seller's market with lots of offers, a seller may not be willing to negotiate the price based on the appraised value of the home. An appraisal clause can help you get a head start on other potential buyers by signally early how you will handle a low appraisal.
Option 1: All Out Appraisal Clause: This type of clause states that no matter what is the appraised value of the home, you as the buyer will make up the difference and pay what you offered for the home. For example, if you have an offer price of $1 million and an appraised value of $900,000 then your appraisal clause states that you will bring the extra $100,000 to the table at closing in order to close the transaction. This full price appraisal clause is obviously enticing to the seller as they know that they will receive the full offer price, especially if it is possible that the appraisal price will be lower.
Option 2: Capped Appraisal Clause: This type of appraisal clause provides a cap above the appraised value that the potential buyer is willing to spend. For example, your appraisal clause could state that you will pay the appraised value plus $10,000 up to a cap of $950,000. While this type of appraisal clause works best for a buyer with certain budget limits, depending on the market, it may make your offer less appealing to the seller.
But remember, the appraisal clause only kicks in if the appraised value is less than the offer price. As you consider an offer for a property, it is important that you look closely at your finances and discuss options such as appraisal clauses with your realtor so that you can make the best possible offer.
Hopefully this provides you with an understanding of appraisal clauses. If you have additional questions, please feel free to reach out and ask!