The Difference Between Loan and Appraisal Contingencies

This question was asked by a Trulia Blogger. Here was the question.

I am trying to understand the difference between both. If there is an agreement to put 20% on a home with no appraisal contingency and if the bank estimates the home to be of much lower value would the situation not be covered by loan contingency (since bank may refuse to give the loan asked for)? What is the use of the appraisal contingency in cases where buyer only puts 20% down?

Here was my response.

The two are interrelated but there is a sharp difference between them. What is implied by your post, I would characterize as loan contingency consideration. In other words it strength of buyer in regards to financing.

(Lets start by discussing) the financing. Lets say we have a 400k loan and a buyer with 20% down payment of 100k on a 500k purchase. I use this beacuse I can do the math in my head easily. So buyer is in contract and the home appraises for 450k. Now like you descibe there is no problem with the loan approval. The buyer puts 90k down instead of 100k and you go to close right? Well no. A an appraisal contingency states that the contract is valid only if the property appraises for price on the contract. The buyer can now walk away. Right? Well no.

This is one way realtors make their money. Realtors make money by getting contracts to close. Our contracts state that the buyer just cant walk away. Buyers have to give the sellers a chance to reduce the sale price to the appriasal or get another appraisal (or lately go through an administrative appeals process which I wont get into here.) Clearly the buyer isn't going to balk, they loved the house at 500k at 450k it would be assumed they are now ecstatic.

Lets now say that the sellers pay for a 2nd appraisal and they lose the administraitve appeal. The value of the home is $450 per appriasal and there is an appraisal contingency and the contract says 20% down. The seller says, "I don't care, but I'll take 475k and I won't take a penny less." Now, we know the buyer can offer the seller the additonal 10k (The difference between 20% of 500k vs 20% of 450k) without a problem. The loan contingency though says that the buyer can only put down 20%. There is a 15k gap.

This is why there is a separate contingency for loan and appriasal.

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