There are really two contingencies that comprise the “mortgage contingency”: (1) the risk that the sellers won’t be approved for the mortgage because of their credit risk as judged by the bank; and (2) the risk that the property won’t appraise for a value equal to, or greater than, the agreed purchase price. Buyers generally already know through the preapproval process how much money they can borrow, and at what rate, given their credit rating, salary, savings, assets, etc. So, the first type of risk is generally mitigated before the contract is signed. The risk that a property won’t appraise at a high enough price does not get mitigated until AFTER the contract is signed and an appraisal is conducted. What exactly is this risk? This risk is no less than the entire amount of your downpayment!
The bank will only loan you a percentage of the appraised value of the property. If the property does not appraise for the contract price or higher, then the bank will only be lending you a percentage of that lower value. If the buyer waives this contingency upon entering the contract, and the property appraises for a value lower than the contract price, the buyer must come up with the difference between the contract price and the appraised value at closing or forfeit his downpayment.
Example: Buyer contracts to buy a Condo for $1.3M, putting down 10%, or $130,000. The appraisal comes in at $1.2M. At closing the bank will lend the buyer whatever percentage of $1.2M that was bargained for (let’s assume 80% of the purchase price, or $1,040,000). So, the buyer now has $1,170,000 of the purchase price and had expected to add only the other 10%, or $130,000, at closing to complete the deal. Instead, the buyer must come up with another $100,000 to complete the deal. If he doesn’t, then he loses his $130,000 downpayment.
Lesson: Unless you know that you have the funding to make up whatever difference there may be between the contract price and the appraisal price, NEVER waive the mortgage contingency!
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