How Buyers Can Deal With a Low Appraisal
An appraisal gap occurs when a home's appraised value is less than the buyer's offer. When this happens, you may need to pay the difference out of pocket, renegotiate with the seller, or explore other options to keep the deal on track.
An appraisal gap can arise in any market condition, though it’s more common during periods of rapid home price increases. However, it can also occur in declining markets.
What Happens when the Appraisal comes in Low?
When facing an appraisal gap, you have several options:
Pay the Difference in Cash
Cover the gap between the appraised value and your offer by paying the difference in cash. Mortgage lenders won't loan more than the appraised value, so any shortfall must be paid out of pocket.
Example: If a home appraises for $300,000 and you offered $330,000, the lender will base the loan on the appraised value. If your loan requires a 5% down payment, the maximum loan amount would be $285,000 (95% of $300,000). You'll need to cover the remaining $45,000 out of pocket.
Renegotiate with the Seller
If your purchase contract has an appraisal contingency, you can negotiate with the seller to lower the price to the appraised value or split the difference. The seller may accept, counter, or decline your offer, depending on their circumstances and market conditions.
Request a Review of the Appraisal
If you believe the appraisal is inaccurate, you can request a review. Your agent can help you gather evidence and submit a reconsideration of value. Keep in mind this process can be time-consuming, and there's no guarantee the appraised value will change.
Apply with Another Lender
You can try applying for a mortgage with a different lender in hopes of getting a more favorable appraisal. This option also takes time and might not be feasible in a competitive market where the seller has other offers.
Walk Away
If you have an appraisal contingency, you can walk away from the deal without penalty. This is the least risky option but may not be desirable in a competitive market.
Appraisal Gap Coverage Limits Your Exposure
In competitive markets, some buyers waive the appraisal contingency to strengthen their offer. However, this can be risky if the appraisal comes in low. An alternative is to include an appraisal gap coverage clause in your offer.
Example of an Appraisal Gap Coverage Clause
Consider a home with a purchase price of $400,000 that appraises for $350,000, creating a $50,000 gap. If you include an appraisal gap coverage clause stating you'll cover up to $30,000 of the gap, you’d proceed with the purchase if the gap is $30,000 or less. If the gap exceeds $30,000, you can withdraw your offer and retain your deposit.
Strengthening Your Offer
To make your offer more attractive, especially in a bidding war, provide proof of funds demonstrating your ability to cover the appraisal gap. Including a preapproval letter and financial documentation can make your offer more credible.
Conclusion
Dealing with an appraisal gap requires careful consideration of your financial situation and the market conditions. Whether you choose to pay the difference, renegotiate, seek a new appraisal, or walk away, understanding your options and being prepared can help you navigate this common home-buying challenge effectively.
