When hunting for a new home in a competitive real estate market, buyers could find themselves in a bidding war, leading to a high purchase price. The buyer who successfully outbids the competition and whose offer is accepted may end up in an appraisal gap situation.
An appraisal gap happens when the appraised value from your mortgage lender comes back lower than the purchase price you’ve offered. In these cases, you could be on the hook to make up the difference or walk away without your earnest money.
The good news is that understanding appraisal gaps can help you navigate this scenario.
What is an appraisal gap?
An appraisal gap is the difference between the contracted purchase price and the appraised value. Home appraisals are based on the condition of a property and comparable sales (or “comps”) in the area. Taken together, these determine the property’s fair market value.
For example, let’s say you offer $300,000 for a house. The seller accepts that amount, but then the house is appraised for $280,000. The $20,000 difference is an appraisal gap.
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How to deal with an appraisal gap
If you’re in the homebuying process and end up with an appraisal gap, here are a few steps you can take:
Include an appraisal gap clause in your offer
If you haven’t made an offer yet, you can include an appraisal gap clause in your initial offer. An appraisal gap clause is a contingency that can be written into the purchase agreement to help protect the buyer and seller from having to renegotiate when an appraisal is too low. The coverage clause can state how much of an appraisal gap buyers are willing to cover. You can include financial documentation and a mortgage pre-approval to prove you are prepared to cover a potential gap.
As an example, let’s say you make an offer for $300,000 with an appraisal gap coverage clause for up to $20,000. If the appraisal comes back at $280,000, your contract is still in effect. But if it comes back at $275,000, you would be released from the contract without losing your earnest money deposit.
Pay the difference
If you still want the property and you have the means, you can choose to pay the difference between the appraised amount and purchase price. This means that the lender only covers the appraised amount for your loan, and the rest will be added to your closing costs as part of a cash down payment.
In the above example, that would add $20,000 to your closing costs to cover the gap between the offer price of $300,000 and the appraised value of $280,000.
Renegotiate the price
If you’re already under contract and end up with an appraisal gap, you can contact the seller and try to renegotiate the terms of sale. You could ask them to lower the purchase price or split the cost of covering the appraisal gap. Be aware, though, the seller is under no obligation to adjust the price based on the appraisal.
Get new financing and a new appraisal
If you feel the appraiser has missed important details or otherwise undervalued the property, you can dispute the appraisal with your lender. You should be prepared with strong evidence to support your claim. Depending on the lender, you may even be able to order another appraisal from a different company, just be prepared to cover the additional cost. Take note: The new appraisal isn’t guaranteed to come back higher.
What happens if the appraisal comes back higher than the selling price?
When a home appraisal comes back higher than the offer price, you’re essentially paying below market value. (Congratulations on landing a deal!)
Keep in mind: When a home appraises for higher than what you agreed to pay, it doesn’t change the loan amount you qualify for — or the amount you’ll need for your down payment.
Can a seller back out after an appraisal?
For the most part, sellers are obligated to follow through with a sale, even if the appraisal comes back higher than the purchase price. However, contracts can be customized to include any number of conditions. Be sure you understand the terms of the sale before you sign.
Minding the gap
Appraisal gaps can be common when real estate is booming. Understanding your options can help you make the best homebuying decision in a hot housing market.
