With many markets in Wisconsin experiencing stiff competition among buyers interested in the same property, one trend emerging is buyers are not including an Appraisal Contingency in an offer to purchase to induce the seller to select that offer. The apparent appeal for a seller to choose an offer without an Appraisal Contingency is that if a buyer offered over list price or competition resulted in buyers outbidding each other up to a purchase price that probably will not be supported by the lender’s appraisal, the buyer will not be able to get out of the offer if indeed the lender’s appraisal is less than the agreed upon purchase price. That may be true. Sometimes. Other times, what this means is the lender ultimately issues a rejection letter or offers financing on terms other than those included in the buyer’s Financing Commitment Contingency and therefore the Financing Commitment Contingency cannot be satisfied.
A brief history of the Appraisal Contingency in the Wisconsin offers to purchase
Why can a buyer sometimes get out of a transaction where the offer did not include an Appraisal Contingency, yet it is the appraisal that prevents the transaction from moving forward? To understand why some buyers with only a Financing Commitment Contingency and not an Appraisal Contingency can get out of a transaction due to an appraisal less than the purchase price and others would not be able to, it is necessary
to take a short walk down memory lane and learn how we arrived at our current version of the Appraisal Contingency.
2010 WB-11 Residential Offer to Purchase
The Wisconsin offers to purchase first saw the introduction of an Appraisal Contingency in the 2010 WB-11 Residential Offer to Purchase, which had a mandatory use date of March 1, 2010. One of the primary reasons for adding an Appraisal Contingency at that time was to address how lenders were issuing loan commitments. Many lenders followed the practice of issuing a loan commitment subject to an appraisal. The buyer would deliver the loan commitment according to the terms of the offer to purchase, thereby satisfying what was then known as the Financing Contingency. Subsequent to issuing the loan commitment, the lender would have the property appraised. If the property did not appraise at or above the purchase price, the lender would choose not to make the loan and the buyer would very likely end up in breach of contract because the buyer could not close on a transaction where all the contingencies had been satisfied.
The primary reason to include an Appraisal Contingency in an offer to purchase is to protect the buyer against becoming contractually obligated to purchase a property that does not appraise at or above the purchase price and, as a result, the lender will not make the loan. If the buyer uses a separate Appraisal Contingency and receives a loan commitment subject to an appraisal, the separate Appraisal Contingency is not waived by delivering the loan commitment to the seller. If there is no separate Appraisal Contingency and the buyer delivers a loan commitment that is subject to an appraisal, the buyer is assuming the risk that the property will appraise at the required value. If the property does not appraise at that value, a buyer without a separate Appraisal Contingency may end up in breach of contract if the buyer does not close. If an independent Appraisal Contingency is used, the buyer is protected and is not in breach if the property does not appraise at the required value, even if a loan commitment subject to an appraisal had previously been submitted to the seller.
2011 WB-11 Residential Offer to Purchase
The Appraisal Contingency remained largely the same in the next round of revisions to the WB-11 Residential Offer to Purchase, which had a mandatory use date of July 1, 2011. This next round of revisions to the WB-11 Residential Offer to Purchase came just a little over one short year after the last revisions. This just goes to show that the back-to-back revisions to the WB-11 Residential Offer to Purchase in 2020 are not totally unheard of!
While the Appraisal Contingency remained largely the same in the 2011 WB-11 Residential Offer to Purchase, it did receive some minor changes to improve its function. The 2010 WB-11 Residential Offer to Purchase indicated that the buyer had to deliver a notice objecting to the appraisal along with a copy of the appraisal report to the seller and the listing broker. The listing broker is not a party to an offer and as such, it did not really make sense to require the buyer to deliver a notice and a copy of the appraisal report to the seller and the listing broker, so the 2011 WB-11 Residential Offer to Purchase directs a buyer who is objecting to an appraisal to deliver a notice and a copy of the appraisal report to just the seller or the seller’s recipient for delivery, if any, per the delivery terms of the offer.
2020 WB-11 Residential Offer to Purchase – Round 1
The WB-11 Residential Offer to Purchase went unchanged from 2011 until the very end of 2019, when, after many, many months of careful and considered suggested improvements, it was time to reveal the new and improved WB-11 Residential Offer to Purchase, which had a mandatory use date of January 1, 2020. With this revision, the Appraisal Contingency included a significant change in that the parties could now negotiate whether the seller would have the right to cure if the appraisal was lower than the agreed upon purchase price. Allowing the parties to negotiate a right to cure opened up a whole new opportunity to negotiate around the Appraisal Contingency. In both the 2010 and 2011 versions of the Appraisal Contingency, if the appraisal was lower than the agreed upon purchase price, the buyer could give a notice objecting to the appraisal and a copy of the appraisal report and that was it; the offer was null and void. The buyer, of course, did not have to go right to delivering a notice objecting to the appraisal but could have offered an amendment and negotiated a resolution through continued negotiations similar to how parties often attempt to negotiate around defects using amendments before a buyer decides to issue a Notice of Defects. By including an optional right to cure, though, the seller now had some leverage even in the initial negotiating process to determine the terms of the offer.
Much like the right to cure provision in relation to the Inspection Contingency, a right to cure in relation to the Appraisal Contingency is often an appealing provision for a seller. It gives the seller some options if the appraisal is lower than the agreed upon purchase price and the buyer issues a notice objecting to the amount. If the appraisal is lower than the agreed upon purchase price, and the difference between the purchase price and the appraisal is an amount the seller can live with, the seller can choose to cure by issuing a notice that the seller is going to cure, and then the buyer and seller amend the offer to the appraised value. If the difference between the purchase price and the appraisal is too much or the seller thinks the discrepancy in the amounts is not justified, a seller can choose not to cure, making the offer null and void and giving the seller the opportunity to negotiate with other potential buyers.
What is happening in the current market?
Where there is competition among buyers, it can lead to buyers offering to pay more for a property than what its likely appraised value will be. If a buyer was concerned about paying more for a property than its appraised value, the buyer would simply include an Appraisal Contingency, thereby making use of the protection that was the original goal of including an Appraisal Contingency in the offer to purchase. When a buyer is competing with other buyers, however, every extra contingency and condition a buyer includes in the buyer’s offer might reduce the chances of that buyer’s offer getting accepted. As a result, what listing agents and sellers are seeing is buyers who are drafting offers without many of the more common contingencies, including even inspection contingencies.
Consider the following scenario: A seller receives six offers, all of which are above list price. For ease of comparison, all the offers include a Financing Commitment Contingency, but three offers also include an Appraisal Contingency. The seller considers the possibility that the property will not appraise at purchase price or better, so the seller immediately rejects those offers that include an Appraisal Contingency. From the remaining three offers, the terms are all identical except for price, so like any rational person, the seller picks the one with the highest purchase price. This transaction is going to go one of two ways, and how it turns out is going to depend entirely on the lender’s process for issuing a loan commitment.
Option 1
This buyer’s lender has a process where the lender will issue a loan commitment subject to the appraisal. The lender issues a loan commitment subject to the appraisal. Per the terms of the WB-11 Residential Offer to Purchase, if the buyer qualifies for the loan described in the offer or any other loan acceptable to the buyer, the buyer agrees to deliver to the seller a copy of the written loan commitment. There is even a “Caution” in the WB-11 Residential Offer to Purchase alerting buyers that loan commitments may contain conditions. Conditions may include an appraisal, credit check, verification of employment and others. With the loan commitment in hand, the buyer delivers it accompanied by the buyer’s written direction to deliver it to the seller, thereby satisfying the Financing Commitment Contingency. So far, so good — but then the lender orders an appraisal of the property. The appraisal is lower than the agreed upon purchase price, so the lender decides not to make the loan even though the buyer already satisfied the Financing Commitment Contingency. This buyer, whose offer did not include an Appraisal Contingency, is likely going to end up in breach of contract because the buyer will not be able to close and there are no unsatisfied contingencies that could give the buyer a way out of the transaction.
Option 2
This buyer’s lender has a process where the lender will not issue a loan commitment until after the property has been appraised. The buyer applies for a loan, the appraiser conducts the appraisal, and the appraisal is for less than the agreed upon purchase price. Because of the low appraisal, the lender issues a rejection letter, or issues a loan commitment, but it is on significantly different terms than the buyer included in the buyer’s Financing Commitment Contingency. In either case, the buyer is going to be able to deliver a notice to the seller that financing is unavailable and therefore the Financing Commitment Contingency cannot be satisfied, alleviating the buyer of an obligation to close the transaction. In short, this buyer gets to get out of the transaction without an Appraisal Contingency even though the underlying issue was the appraisal.
The moral of the story here is that just because a buyer’s offer does not include an Appraisal Contingency does not mean that the buyer will not be able to get out of a transaction when the problem is with the appraisal. It all depends on the lender and whether the lender issues a loan commitment subject to the appraisal or the lender does the appraisal first and then decides whether to issue the loan commitment. In a competitive market, sellers should be cautioned that just because an offer does not include an Appraisal Contingency, it does not mean that the appraisal will not be an issue. Depending on the lender’s process for issuing a loan commitment, a buyer could possibly still get out of the transaction under the Financing Commitment Contingency because the lender issues a rejection or because financing is not available on the terms in the buyer’s offer.
Jennifer Lindsley is Staff Attorney and Director of Training for the WRA.