Sellers should consider an appraisal addendum

As we are again finding ourselves in a competitive market, with sellers in many cases receiving multiple offers, one issue that has re-surfaced is the concept of “waiving the appraisal contingency.”   What does this mean to a buyer and seller?    First, a little history.

History of the GCAAR Appraisal Contingency

The concept of an appraisal contingency has been contained in the various versions of the GCAAR contracts, but the language has been revised – and moved around – over the years.

In the 1999 GCAAR contract, the appraisal contingency was automatically part of the contract as an element of the conventional financing paragraph (Paragraph 8) unless a purchaser specifically eliminated it.  Back in the bidding war days of the early 2000’s, this was often done.  Purchasers struck through the language contained in that paragraph.  Hence the origin of the phrase, “waiving the appraisal contingency.”  

In the 2006 revision of the GCAAR contract, the purchaser was required to select between two options listed under Paragraph 10, Conventional Financing Terms.  Under Option 1, the contract was contingent on an appraisal not less than the sales price, and under Option 2, it was not contingent.   Under Option 2, “Purchaser shall complete Settlement without regard to the value of the Property set forth in any Appraisal and acknowledges that this may reduce the amount of financing available from lender and may require Purchaser to tender additional funds at Settlement.  If Purchaser fails to settle except due to any Default by Seller, then the provisions of paragraph #26 (Default) shall apply.”  This language was continued in the 2009 version of the contract.

In the 2012 revisions to the GCAAR contract, two of the big changes were to move the financing contingency to a separate addendum of its own and to move the appraisal contingency to the Addendum of Clauses.  Also, the language of the appraisal contingency was revised.

Appraisal contingency in addendum of clauses Rev. 2012

When sellers and their agents are reviewing offers today and evaluating what the offers say on the question of an appraisal contingency, they first look to see whether Paragraph 10 of the Addendum of Clauses is checked off, because this is where the appraisal contingency is now located. 

If this paragraph is checked off, the contract is contingent on appraisal not less than the sales price.  For example, if the offer is for a sales price of $1,000,000 with financing of $800,000, and the appraisal comes back at $900,000, the purchaser is not obligated to proceed with the contract and can instead negotiate with the seller to lower the sales price.  That much is clear.    

The bigger question is what if this paragraph is NOT checked off?  A seller might think that because there is no specific appraisal contingency, he or she would be protected against the contract falling through based on a low appraisal.  But that is not necessarily the case, if the contract includes a financing contingency.

If the contract contains a financing contingency, and if the lender denies the loan within the timeframe of the financing contingency based on the appraisal, the contract will become void if the buyer delivers a copy of the written rejection to the seller, and the buyer will not be in default, notwithstanding the fact that the buyer did not even check off Paragraph 10.  The buyer is protected.  

The Conventional Financing Addendum specifically states:

In the event Buyer’s financing described herein is declined based upon the Appraised Valuation of the Property, Buyer will not be in Default.  This provision will apply even if the Contract contains a separate Appraisal Contingency and that Appraisal Contingency has expired or has been removed.

(Paragraph E.)

The appraisal contingency itself contains the following language:  

“IF THIS CONTRACT IS CONTINGENT UPON FINANCING AND SUCH FINANCING  IS

DECLINED BASED UPON THE APPRAISAL, THE BUYER WILL NOT BE IN DEFAULT, EVEN IF THIS APPRAISAL CONTINGENCY HAS BEEN REMOVED.”

This language would apply most directly in a situation where Paragraph 10 had been checked off, but the purchaser subsequently delivered to the seller a notice that the appraisal contingency had been removed (e.g., GCAAR form #1333).   In this case, as well as in the case where the paragraph had never been checked off, the seller would not be protected in a situation where a low appraisal resulted in the buyer’s financing being denied.

Obtaining a separate addendum

So what’s a seller to do?  The best way for a seller to be sure that they are protected in the case of a low appraisal, where there is a financing contingency, is to not only make sure that there is no appraisal contingency contained in the contract (i.e.,  make sure that Paragraph 10 in the Addendum of Clauses is not checked off) but also to include an addendum to the contract that specifically states that if the appraisal comes back low, the purchaser will complete settlement and make up the difference in cash.  This would be very similar to the language contained in the 2009 version of the GCAAR contract.     

The following is some suggested language for an addendum:

THIS CONTRACT IS NOT CONTINGENT ON AN APPRAISAL.  Purchaser shall proceed with this Contract at the stated Sales Price without regard to the Appraised Valuation of the Property.  In the event that the Appraisal reduces the amount of financing available from the Lender, Purchaser shall tender additional funds in cash at Settlement.  

Of course, from the buyer’s perspective, the buyer needs to be certain that he or she has the necessary cash to cover such a shortfall before including a provision like this in an offer.