When you are buying a home, there is the possibility that what you’re paying for a property may be deemed too high. If you are getting a mortgage, your lender will send a licensed appraiser to perform a house appraisal.
The lender wants to ensure that there is proper equity in the property in the event of a borrower defaulting on the loan.
If the fair market value comes in lower than the agreed-upon purchase price, there is a gap in the real estate appraisal. When there is a low appraisal, there are some potential options.
Many buyers will ask their real estate agent what they can do when there is an appraisal gap. These are the possible things that you’ll be tasked with deciding.
- You can back out of the sale due to the inability to procure financing.
- Ask the seller to lower the property’s sale price to match the appraised value.
- A buyer can increase their down payment to make up the difference between the purchase price and appraisal value.
- A compromise can be made between buyer and seller. The seller will agree to reduce the price, and the buyer will agree to increase their down payment by an agreed amount.
- Fight the validity of the low appraisal and attempt to get the appraiser to change the value.
- Switch to a different lender and get a new appraisal.
Let’s look at each option when there is an appraisal gap in more detail.
Terminate The Purchase Agreement Due to The Mortgage Financing Contingency
A financing contingency is one of the most common contingencies in a real estate contract. It gives the buyer the right to procure a mortgage with a lending institution.
The language will state how much is being borrowed, along with the time the buyer will need to have a financing commitment from the lender. It is one of the most crucial timelines in a real estate contract.
The lender could deny the financing when an appraisal comes in lower than the purchase price. In that case, the buyer would be forced to protect their interest under the clause and ask for the return of their earnest money.
Get a Reduction in The Sales Price
The second option when there is an appraisal gap is to ask the seller to lower the home’s purchase price. In many circumstances, a seller will be reluctant to do this, especially in a seller’s market.
If the current real estate market is hot, the seller will likely be able to put the home back on the market and get their desired price from another potential buyer.
On the other hand, if it is a buyer’s market, it may be in the seller’s best interest to reduce the price and move forward with the sale.
The Buyer Increases Their Down Payment
When the real estate market is hot, and there are numerous bidding wars, it is not unusual for some appraisals to come in low. Buyers are bidding up sales prices tens of thousands of dollars over the current real estate comps suggest.
In cases like this, buyers are often forced to increase their down payment if they want to get the house. In order to make up the gap, a buyer will make their down payment larger to give the lender a more significant piece of equity.
For example, if you buy a home for $500,000 and put 10 percent down, the lender will loan you 90 percent of the appraised value. If the appraisal comes in at $475,000, the mortgage lender will only lend 90 percent of that amount.
A buyer would have to make up the difference to satisfy the lender. In order to write a winning offer, buyers are adding appraisal gap coverage language that says they will agree to cover any shortfall with a low appraisal.
A Compromise is Made Between Buyer and Seller
Sometimes there will be a compromise that is made where the buyer will increase their down payment some, and the seller will drop the price by an agreed amount. It will be a combination of the options above to satisfy the lender.
Keeping the sale together is a win-win for both the buyer and seller.
Challenge The Appraised Value
Every so often, an appraisal will come in with what looks like mistakes. Remember that a real estate appraiser is human, just like the rest of us. They can and will make mistakes. When the value comes in low, which is a big surprise, there could be problems with the appraisal.
It usually takes a very skilled real estate agent to win an appraisal dispute. You will need to provide clear evidence as to why there should not be an appraisal gap.
Change Lenders So There is a Different Appraiser
The last option for an appraisal gap that can’t be resolved is to get a new lender. The appraiser involved should also be different when you have a different lender.
The cost of a real estate appraisal will be in your closing costs. It is only a few hundred dollars, so it is not a significant amount of money to lose in the grand scheme of things.
It is unlikely the second appraiser will come in with the same value. However, there is also no guarantee that they will come in with a satisfactory value either. The second appraisal could have a gap as well.
Unless you are putting down a substantial amount of money with your purchase, there is likely to be a real estate appraisal performed. Home appraisals are an integral part of most transactions to protect the financial interests of lenders and buyers.
You should now have a much better understanding of what happens when there is an appraisal gap.
Some great options for those unfortunate enough to face this situation. Thanks, Bill.