What are Appraisal Escalation Addendums and how can they help?

At Diamond Real Estate Law, our team helps with hundreds of real estate deals every year, and we see a lot of “interesting” things. 

One trend we’ve noticed lately is that our partner realtors sometimes need help avoiding losing deals and clients due to appraisal issues.

They deal with frustrated clients about properties not appraising at the purchase price, clients who freak out about a low appraisal after they have warned their clients hundreds of times that the offer is higher than any comparable sales. They lament not being able to educate clients about this issue ahead of time or resolving it by mapping out a strategy.

Now, from our McHenry Illinois team of real estate attorneys, we could have the solution for you: an appraisal escalation addendum.

Most realtors have heard of these addendums and know the basic concept, but here’s how they work. The addendum is an added part of the contract that confirms:

If the property appraises below the purchase price, the buyer agrees to pay money above the appraised value.

For example, let’s say the buyer offers $100,000 for a home. 

To make her offer stronger, the buyer adds an appraisal escalation clause. The clause/addendum states that if the property appraises below the purchase price the Buyer will agree to contribute $5,000 above the appraised value. 

If the property appraises for $100,000 nothing happens.

If the property appraises for $95,000, the Buyer agrees to contribute the additional $5,000 they will need to get their loan.

It sounds simple, right?

Of course, as we get people’s emotions involved, and maybe a few attorneys, things can get a little more complicated.

Here are two of the most common issues we see with appraisal escalation addendums:

1. What happens if the appraisal is slightly below the purchase price and the escalation will cause the Buyer to pay more than the contract purchase price?
2. What if the Buyer wants to re-configure their loan to accommodate the difference between the purchase price and the appraised value?

Here is an example of an addendum I’ve seen that tries to address these issues:

In the event the property does not appraise for the full Purchase Price as agreed to in the Contract, the Buyers agree to pay, in cash, up to $___________ over the appraised value.  The amount of cash paid will be the full $_________ unless adding this full amount would cause the agreed Purchase Price to be exceeded.  In this case, the amount of cash paid would be only enough to meet the difference in the appraisal value and the purchase price.

Should the buyers choose, but may only choose AFTER the appraisal is completed, to change their loan parameters to accommodate any difference in the purchaser price and the appraisal value, they may do so ONLY if it does not change their qualification status for the loan.  Any such change requires notification via attorneys.         

[NOTE: This is just an example. If your Managing Broker or Local Realtor Association recommends or requires you to use a certain form or addendum for this situation, it’s always best to stick with their recommendation.]

In my opinion, the example above is a bit wordy and confusing. Unfortunately, the more exceptions and situations that we try to resolve or anticipate, the more complicated the addendum gets.

This is why, if your client is concerned about this type of addendum or situation, it is always best to refer them to a real estate attorney to help them figure out which flavor of addendum they want — the long one that tries to cover everything or the short one that just gets to the point.

I can’t speak for other attorneys, but if my team is just advising a client and drafting a simple rider like this (even the long version above) we usually do not charge extra. 

An appraisal escalation addendum is not always a silver bullet that slays every appraisal monster that rears its ugly head, but it can address some of the most common appraisal  problems. 

It also gets clients, and everyone involved in the deal, proactively thinking through all the crazy appraisal issues we are seeing in the marketplace.

Are you interested in learning more about appraisal escalation addendums? Our McHenry, Illinois attorneys are here to answer your questions. Contact us today to schedule a consultation.