There are a few contingencies that are listed on the California Purchase Agreement. They can be a bit confusing so today we'll focus on the mortgage/financing contingency and an appraisal contingency. The thing to remember is that a mortgage contingency and an appraisal contingency are not the same thing.
1. A Mortgage Contingency, sometimes also called a financial contingency or loan contingency, protects you if you are unable to get funding for your mortgage. Under a financial contingency, you aren’t locked into your home sale until you receive a concrete approval letter/commitment letter from a mortgage company. A commitment letter means the lender has fully vetted your ability to pay, reviewed all your required documents and locked in your rate. In the event the lender doesn't approve your loan, you should be able to get your down payment back. You should NEVER release this contingency unless you are absolutely sure the lender has everything it needs to fund. Once the contingency is released, regardless of financing, you are obligated to purchase the home or forfeit you earnest money deposit (usually around 3% of the purchase).
2. An Appraisal Contingency is a clause in a contract that involves your lender ordering a home appraisal during your loan application..... an independent licensed appraiser then evaluates the property, its condition, location, comparable sales, signed contracts, etc resulting in a written professional opinion of how much the property is worth. Should this appraisal come in lower than the contract offer price, a contingency would allow you to renegotiate the price, have the seller provide cash back/credit at closing, or back out of the sale. Without an appraisal contingency, however, the option to walk away might not be available to you. You could be at risk of breaking the contract and losing your earnest money deposit, at the very least.
There is an appraisal gap clause in the California contract that can be utilized to protect you as the buyer in the event the home doesn't appraise at the price you offered. For example, if the purchase price was $1,200,000 and the appraisal comes in short at $1.000.000 and the buyer has written in a value of $1,100,000 as the appraisal gap clause, the buyer has agreed to bring in an additional $100,000 over appraised value to purchase the home (their maximum threshold). If the Sellers accept this clause during negotiations, they agree to take the risk that the appraisal may come in lower than the offer price. If they want a guaranteed offer price of $1,200,000 they may refuse to accept the gap and wait for another offer. Appraisals haven't been an issue in the last few years but when a market softens, appraisal gaps can occur.
Lenders use loan to value ratios and debt to income ratios to determine a buyer's ability to pay so if the appraisal doesn't come in at value, the loan to value changes and with that, the amount the bank is willing to lend to them. Buyers often get confused about these contingencies because from their point of view, if the appraisal comes in too low and the bank won't lend them the original financed amount, they shouldn't have to proceed with the purchase. From the lender's perspective that is true because they won't fund the loan but from the Seller's perspective, they expect the buyer to honor their contract and come up with the difference with their own funds.
Lots to consider so make sure to speak to your real estate professional about these options before writing your offer.