It’s a tough market out there right now if you’re a homebuyer. Between low inventory and sky-high prices, many homebuyers are also having to deal with something called an “appraisal gap.” Yes, it’s already hard enough today to get a home under contract – meaning your offer on a home has been accepted by the seller. Sorry to break the news to you, but your journey to buying a home isn’t over yet. You still have about 4-8 weeks of finalizing paperwork and making sure all the contingencies are met. One of the biggest hurdles homebuyers are running into after their offer on a home is accepted is the appraisal gap, where a house is getting valued under what the price is stated in the contract.
As a buyer, a home appraisal is required by your lender in order to finalize the loan amount they give you. An appraiser will evaluate the home’s value by looking at various factors such as zoning, lot size, location, square footage, general condition of the home, and etc., and comparing the home to other properties that have sold in the area.
Unsurprisingly, as you’ve probably noticed while you’ve looked at homes, the low inventory and high demand have driven up home prices. According to NAR in their Realtors Confidence Index, an estimated 54% of homes are getting offers over their listing price. This is great for sellers as homes are selling fast and for a premium. However, an appraisal gap can be tricky to deal with for both the buyers and sellers because both sides of the party have to come up with an agreement of some sort before the house can officially close.
What happens when you have an appraisal gap?
Unfortunately, the price of the home does not get knocked down to what the appraisal says. Someone will have to make up the difference, and that responsibility typically falls on the buyers. An appraisal is one of the requirements asked by your lenders to essentially make sure that the price of the home is fair for all parties involved – lender, seller, and buyer. If the appraisal price is lower than the contract price, your mortgage lender will not be covering the difference when they give you your loan. This appraisal gap difference will also not be lumped in with your down payment. In other words, if a house is $510,000 and the appraised value is $500,000 with a gap of $10,000, you will have to pay that $10K plus your 20% down payment of $102,000.
(Expert Tip – Although 20% is the “golden rule”, you can pay less. In fact, the average percentage our clients put down on their new homes is 6%).
One of the biggest setbacks to having an appraisal gap is that your timeline will be delayed. If the sellers are moving into a new construction home, they may feel more pressured to quickly find a solution – either to find another buyer willing to pay the difference or to be more understanding in reaching a compromise.
What should you do if you have an appraisal gap on your hands?
When you have an appraisal gap on your hands it can be tricky and many things can happen. While having a low appraisal doesn’t always mean your deal is canceled, depending on the situation, you as the homebuyer might walk away and say “forget it” and the sellers will have to relist and find someone who is willing to pay for the additional gap. In some instances, during a buyer’s market or under specific circumstances, when sellers might be more motivated to sell their home, they may step up and cover the difference in the gap. However, in a seller’s market, you can reasonably expect that buyers will have to make up the difference in some way.
First things first, you’re probably concerned about your earnest money deposit. Your contract should include an addendum named something similar to “home appraisal contingency”. This basically ensures that if the appraisal comes back low, you as a buyer have the option to back out without consequence and get your earnest money back. (If you don’t remember having this, discuss with your agent if this is something you should have.)
The next step is to take a look at the appraisal and figure out if there were any errors and why the appraisal might’ve come in low. Did the appraiser know the area well? Did the appraiser use the right comparables? Was the appraiser inexperienced? These are just some of the questions you can think about to examine why the appraisal came in lower than the contract price. As the buyer, you can ask for a second appraisal if you and your agent find it beneficial.
Let’s say that your second appraisal still came in pretty low, what now? The next best thing is to figure out your finances and negotiate with your sellers and hopefully find a happy solution for both sides. Or, alternatively, you can walk away and work on finding another house.
If you are able to, you can shift your down payment and go for a lower percentage. You can also pay the difference in cash. These are “easy” solutions if you have the extra money, however, we know that that’s not the case for everyone. So you and your agent are going to have to find some way to make up the difference.
What can you negotiate with your sellers on?
The best thing you can do in this situation is to remain flexible. Can you offer your sellers to stay in the home longer or allow them to move out quicker? Can you take on certain repairs the sellers originally planned to make before you moved in? Perhaps they had a bunch of furniture they wanted to get rid of during the move, can you take those off their hands for them? Think about all the “benefits” you can offer your sellers and use those when you’re negotiating. Don’t be afraid to negotiate on the original contract price either – do they have any wiggle room on their purchase price?
The bottom line
Be prepared that you may have to walk away. A dream home that will make you struggle financially isn’t a dream home. Although there may not seem like other houses out there on the market right now, you will still have plenty of chances to find another great home. Who knows, maybe it’s even better than the current one you have your eye on and you’ll be able to afford it.
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