In this article, learn everything you need to know about how to handle an appraisal gap if the situation comes up.
You've heard the nightmare stories before, a friend or family member finds their dream home and puts in the winning offer. They float on cloud nine until the home appraisal comes back for thousands less than what they offered for the home. What do they do?
In today's real estate market, it's more important than ever to be prepared and knowledgeable about the process of buying and selling a home.
Photo by Mikhail Nilov
What Is An Appraisal Gap?
Appraisal gaps occur when there is a difference between the fair market value submitted by the appraiser and the amount agreed to pay for the home.
What Should You Do When The Appraisal Is Less Than The Offer?
Appraisal gaps don't immediately mean the home purchase will fall through. In fact, you have a number of options depending on the circumstances which we'll go over below.
Pay The Difference
In a seller's market, the seller may be hard-pressed to lower the price of the home. With multiple-offer situations being common today, there may be a line of home buyers waiting to take your place with the additional funds available to cover the appraisal gap if you're not willing to do so.
If the seller won't negotiate the price down, you'll be responsible for paying the difference in cash if you don't have an appraisal contingency in the contract. The appraisal contingency allows you to get out of the contract without having to forfeit your earnest money. Without the contingency, you'll need to purchase the home or lose your earnest money if you walk away.
Since lenders base your mortgage amount on the appraised property value, you’re going to need your agreed-upon deposit plus the difference between the sale price and appraised value of the house.
If you don't have the available funds to pay the difference, you have a few different options here as well. You can leverage investments or use some of your retirement funds (possibly without paying a penalty). Additionally, you can also lean on family members for monetary gift letters, just make sure you have the proper documentation.
Renegotiate The Offer
If you've included an appraisal contingency in your sales contract, you may have the leverage to negotiate the sale price of the home with the seller. My recommendation would be to start with the most beneficial outcome for you which is for the seller to lower the price to match the appraised value of the home.
The next step is to ask the seller to meet in the middle and split the difference in the appraisal gap. If you're looking at a $12,000 gap, offer to pay $6,000 if the seller will lower the price by the other $6,000.
Keep in mind that even if you have an appraisal contingency, the seller may have protected themselves as well with what's called a "Kick Out" clause which allows the seller to accept another offer. Contractually, the seller still needs to allow you the option of removing your contingency but if you choose not to, they can choose another offer.
In a seller's market, it's a risky move to attempt a renegotiation if the seller is dealing with multiple offer situations.
Dispute The Appraisal
Look, an appraisal is subjective. It's possible to have three different appraiser reports on what the home is worth and they're all different. And while disputing an appraisal isn't an easy task, it can be done.
If you and your real estate agent find discrepancies or errors in the report, you can challenge the appraisal process by asking for the appraisal to be redone by the same appraiser or a different one. However, this may not end up in your favor.
You may have to pay for the second appraisal out-of-pocket and if the second appraisal comes back the same - or heaven forbid - even higher - you end up on the losing end.
The dispute will need to be put in writing and you'll be required to provide evidence to support your claims. You'll need to prove the appraiser didn't use accurate comparables and offer evidence of more accurate home prices. That they didn't include features or upgrades to the home, or they did not do a thorough appraisal - only viewing the exterior. One way to make sure the appraiser has as much information on the home as possible is if the seller provides a binder containing all the information on upgrades and repairs completed.
You can also apply for a new mortgage with another lender and thereby another appraiser. However, all this takes valuable time that could upset the seller causing them to cancel the deal and accept another offer.
Photo by Karolina Grabowska
Walk Away from the Sale
This is probably the least desirable option, but a viable one. If you’ve taken the time to understand how much home you can afford and you're at risk of paying more than the property is worth, you could find yourself underwater at a later date - and risk losing money if you should ever decide to sell your home.
Before you walk away, though, make sure you understand your contract. If you lack an appraisal contingency or other contingencies that could help, you could be at risk of losing your earnest money entirely.
Your agent and the seller's agent want the sale to go through so they'll do everything in their power to make sure the appraiser has all the information they need to make the best analysis of the home and get the highest home appraisal.
How often do sellers lower the asking price after an appraisal gap?
In times of a Buyer's Market, where home inventory is extensive and sellers are more apt to court potential buyers, there's certainly a possibility that a seller could work with the buyer. However, in a seller's market - like what currently exists - it's going to be very difficult. In seller's markets, there are usually potential buyers waiting in the wings for another chance at the home they wanted, so sellers may just go with the next offer if they have a kick-out clause or similar.
What happens if an appraisal is higher than the offer?
Since the buyer's side is who orders the appraisal, the only time the seller's side is usually told the appraisal amount is if the home did NOT appraise for the agreed-upon sales price.
Photo by Kindel Media
Appraisal Gap Coverage Vs. Appraisal Contingency
Appraisal gap coverage is wording in the contract that binds the buyer to the home even if the appraisal is lower than the offer price. This is yet another reason to pay close attention to the paperwork in a home transaction instead of breezing through it. If this wording is present, ask for its removal or amend the contract to cap how much you're willing to pay to cover an appraisal gap.
The appraisal contingency is of benefit to the buyer as it allows you a legal way to back out of the contract if the appraisal comes in lower than the contract price. Not only does it allow you to back out of the contract, but it also allows you to keep your earnest money.
When Is An Appraisal Gap Coverage Clause Necessary?
In a competitive market that favors the seller, appraisal gap coverage is a way to make your home offer more attractive in multiple offer situations. The clause indicates how much of an appraisal gap you're willing to cover, so the seller may look for this in the offer to know that the deal is still solid if the appraisal comes in a little low. And by indicating how much you're willing to cover, you can protect yourself from being on the hook for more than you're comfortable with.
How do you write an appraisal gap clause?
A good real estate agent should be able to assist you with the different ways to include an appraisal gap in your real estate contract. But the most important aspect of the clause is to indicate the maximum amount you as the buyer are willing to cover.
The following is an example of an appraisal gap clause written into a sales contract from (greatcoloradohomes.com):
“If the property does not appraise for the purchase price, the buyer agrees to pay up to $20,000.00 above the appraised value, but not to exceed the purchase price.”
Photo by Kindel Media
The Bottom Line
If you're unprepared for the possibility of an appraisal gap, the potential problems that can crop up for both the buyer and the seller could mean serious issues with the health of the deal. And, with buyers entering a hot market with bidding wars offering way above the list price, the potential for appraisal gaps increases exponentially.
So, including appraisal gap coverage for sellers and appraisal contingencies for buyers in the sales contract is a smart move to help keep the deal alive right through closing.
If you've been thinking about buying a home, use our free mortgage calculator to see what you could qualify for!
And, if you're on the fence about selling your home, use our free home valuation tool to see what you could get for your home in today's market - then get in touch with us for a more accurate estimate.
