What is an Appraisal Gap in a Real Estate Transaction?
If you need a mortgage to purchase a home your lender will probably require an appraisal. If this is the case a home appraiser be hired to determine the fair market value of the home, which could result in an appraisal gap.
But what is an appraisal gap, and what can you do if you find yourself in this situation?
What is a Home Appraisal?
A licensed real estate appraiser will determine the current value of the home using comparable sales information. The appraiser will visit the property to visually inspect, take photographs, and measurements.
Once the home appraiser views the property in person they will search for comparable sales. They will look for homes similar to the subject property by location, age, number of bedrooms, bathrooms, square footage, condition of the property, and more. Typically they will only use sales that have closed within the last 3-6 months. They will not use homes that are actively for sale on the market.
They will then select 3 comparable properties and make adjustments if needed. Common adjustments made are for features such as the number of bathrooms, square footage, and lot location. So if the subject property and comparable property are almost identical, but one has a larger square footage an adjustment will be made. In addition to the 3 comparables, an appraiser will usually include 3 additional comparable properties to support their comps.
All of this information will then be compiled in the home appraisal to justify the appraised value for the home.
What is an Appraisal Gap?
If the home appraises for less than the contracted price the buyer and seller agreed on there will be an “appraisal gap.” It is sometimes also called a low appraisal or appraisal shortfall, but whatever it is called, it could be a very significant problem in a real estate transaction.
An appraisal gap could delay the purchase of the home, require the buyer to find extra funds, new financing, or even end the purchase completely. But if you find yourself in this situation you have some options.
What Can You Do if You Have an Appraisal Gap?
When the appraisal comes in lower than the contract price, you still have options. These include:
* You can pay the difference between the contracted price and the appraised value
* Renegotiate with the seller
* Ask for an appraisal review if you find errors, this is usually an exercise in futility though
* Go to another lender for your mortgage, who will order a new appraisal, but you may end up with the same appraised value
* Cancel the contract
The option to walk away from the purchase contract could mean you lose your earnest money, but if you have an appraisal contingency this shouldn’t be a problem if you’re within your contingency period.
A Closer Look at Closing the Gap
If there is a difference between the contracted price and the appraised value, the best-case scenario is the seller reduces the price to that value. If a renegotiation with the seller is possible, they could drop the price to the appraisal value. Failing that, they might be willing to meet the buyer halfway to keep the purchase on track. But if there are other buyers lined up, they may be unwilling to return to negotiations.
There is the option for buyers is to pay the difference. This can be a problem for some buyers’ as their finances are often stretched to their limit with their down payment and closing costs, making finding tens of thousands more very difficult.
Questioning the appraiser’s assessment is also an option, but only if they have clearly made mistakes, otherwise this is unlikely to be successful. Buyers can also look to other banks or mortgage brokers for finance, but they still might not get an appraisal that matches their offer, and it will delay the home buying process further.
In the end, the buyer may find the only option is to walk away from the home and cancel the contract. If there is an appraisal contingency in the agreement, they will have their deposit returned.
How Does an Appraisal Contingency Work?
In hot real estate markets with quickly rising house prices, comparable sales data could lag behind the current market situation. This is more likely to lead to offers above assessed market values and create appraisal gaps.
An appraisal contingency written into the purchase contract will allow the buyer to walk away should the appraisal value come in lower than the agreed to price. Since the lender isn’t going to be willing to loan more money than the appraised value, the buying process will become stuck at this point.
If the seller isn’t willing to renegotiate the price, the buyer is going to be left in a very difficult position, but the appraisal contingency offers a way out. When this contingency is triggered, the buyer will get their earnest money deposit back and the purchase agreement will be canceled.
Using an Appraisal Gap Guarantee Clause
If there is a good chance that there will be an appraisal gap, a clause can be added to the sales contract guaranteeing the buyer will cover the appraisal gap. This is useful in a hot sellers market when there is a lot of competition for homes and bidding wars are common.
The guarantee can make a buyers offer more appealing to sellers but does mean they have to be able to cover the appraisal gap. However, this could lead to a buyer potentially having to find more money than they expect, if the appraised value and the contract price are a long way apart. A maximum amount can be added to the clause so that a buyer isn’t committed to spending an unlimited amount to guarantee the appraisal gap.
Final Thoughts
Appraisal gaps can become common when property value is rapidly increasing but there aren’t sales to support the price increase. This is where cash buyers can become king because they don’t need to have an appraisal. However, sometimes cash buyers think they have the upper hand by not needing an appraisal and won’t submit a competitive offer that’s appealing to the seller. I’ve had plenty of financed buyers beat out cash buyers because they submitted a strong offer that included an appraisal gap clause.
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About the Author
Top Wellington Realtor, Michelle Gibson, wrote: “What is an Appraisal Gap in a Real Estate Transaction?”
Michelle has been specializing in residential real estate since 2001 throughout Wellington Florida and the surrounding area. Whether you’re looking to buy, sell, or rent she will guide you through the entire real estate transaction. If you’re ready to put Michelle’s knowledge and expertise to work for you call or e-mail her today.
Areas of service include Wellington, Lake Worth, Royal Palm Beach, Boynton Beach, West Palm Beach, Loxahatchee, Greenacres, and more.
What is an Appraisal Gap in a Real Estate Transaction?
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