What is an Appraisal Gap and Why does it Matter?

When buying a home and doing a loan, there are two figures that really matter: the agreed-upon purchase price and the appraised value of the home.  At times these numbers don’t match up which can cause problems when it comes time to close the deal.  

No seller wants to sell their home for less than what it is worth, and no lender will offer a buyer a mortgage amount more than what the home is worth.

So, what is an appraisal gap?

An appraisal gap is the difference between the purchase price and the appraised value. When the buyer pays more than the property is worth.

The lender will only lend either on the purchase price or appraisal…whichever is LESS. The gap is the difference between the fair market value of a home determined by an appraiser and the amount you agreed to pay for the home. 

The purchase price is what the buyer offered and the seller accepted… which may be more than what an appraiser thinks it is worth. The appraisal is based on other comparable homes that have sold in the area, but it is only the appraiser's opinion.  It is not science.  

Appraisal gaps are popular during times when it’s a hot sellers’ market, with  multiple offers coming in from buyers.  Buyers will stretch and raise their offer just to win the bid…sometimes the offer is well over full price.

An example of an appraisal gap is if you want to purchase a property listed for sale for $300,000, you offer $325,000 and the appraisal comes back at $305,000.  The result is an appraisal gap of $20,000, meaning you are asking your mortgage servicer to lend you $20,000 more than the appraised value of the home, which they will not do.  

How does the Appraisal Process Work?

A home appraisal is an evaluation/opinion report that a licensed appraiser performs to determine a home’s fair market value.  Lenders require a home appraisal to guarantee the amount you will pay for the home is equal to or less than the appraised value. 

Lenders use appraisals to confirm the home is worth enough in case the borrower defaults on the loan.  An appraiser’s assessment is important because it’s your home’s appraisal amount versus the loan amount, which can determine how much money you are allowed to borrow.  

Lenders will not approve a loan for more than the home’s value. An appraiser will use several  factors when evaluating a home’s worth:

Comparable Sales:  An appraiser compares the home to similar homes in the area that sold within the last six months.  In a hot market, they might use more recent sale…like only comps in the past three  months.

A property appraiser will compare and contrast other sold homes.

The Home's Condition:  An appraiser examines a home's safety, sanitation, and soundness.  An appraiser will confirm all systems are functioning, and verify that there are no major issues with the home.

What are my options if there is an appraisal gap?

An appraisal gap can disrupt the transaction, and in some cases, it can send both the buyer and the seller back to the drawing board to find a different property.. 

However, it doesn’t have to ruin the sale as there are several different ways a buyer can handle an appraisal gap that will allow the transaction to close. 

Pay the difference.  The most straightforward resolution with an appraisal gap is for the buyer to pay the difference.  This is not always a viable option financially.  If you have the funds, you can simply pay the difference in cash.  Or if you are comfortable with it, you may be able to cash out some investments or access retirement funds without penalty to pay the difference.  Taking out a second loan to cover the difference may also be an option.  

Additionally, you might be able to show your lender that you can afford the higher-than-expected monthly payments on the mortgage.  Or you might make a smaller down payment to change the terms of the loan, if doing so allow you to afford the higher monthly payments. If you own other real estate, consider using the equity to cover the funds for the appraisal gap.

Renegotiate the contract.  Another option available in an appraisal gap is to renegotiate the purchase price of the home.  This option is especially important if you have an appraisal contingency in the contract (which I will discuss).  

You can ask the seller to lower the price to the appraisal price which they may be motivated to do, given their timeline and investment in the property.  You can also ask them to split the difference or shrink the gap to a level you can afford.

Get new financing and a new appraisal. This is not so easy as the seller will have to agree to extending the contract and starting over. Not to mention that you may get an appraisal worse than the first one.  Remember that an appraisal is only an opinion.

Dispute the appraisal. You  will need a mountain of evidence to prove that the perceived value is incorrect, including showing that the appraiser failed to accurately assess the market and misvalued the property.  This is not easy to do, either, as appraisers seldom admit they made a mistake.

This process is very time consuming and may not be something the seller will deal with especially if there are other offers available to them.

Cancel the contract. This can be a disappointing option but if you are worried about paying more than a property is worth, or there is no other option you can afford, walking away from the sale may be your best choice.  Usually though, a seller may consider reducing the price if it means that the deal will die and they will need to start over.  Also, this same scenario could happen again for the seller.

What is the difference between Appraisal Gap Waiver, Appraisal Contingency, and Appraisal Gap Clause?

When buying a home, especially in a seller’s market you might hear these three words.  While they sound similar, they both have very different meanings. 

Appraisal gap waiver is wording you add to the contract that binds you to pay the difference in case of a short appraisal and still be willing to buy the home regardless of how much the gap is. It is important to pay attention to this area of the contract. Either you are willing to waive the appraisal and accept whatever happens, meaning that you will pay the difference. Or you can put a limit on how much you are willing to pay out of your pocket to cover a possible appraisal gap.

Appraisal gap contingency is wording in the purchase contract that indicates if the property does not appraise you can back out of the contract and keep your escrow deposit. The appraisal contingency gives you a legal way out of the contract if the appraised value is lower than the purchase price. 

Appraisal gap clause often include specific dollar amounts, which indicate how much a buyer is willing to pay, depending on the size of the gap. An example of wording for an appraisal contingency clause is this: buyer and seller agree that if the appraised value comes back lower than the purchase price, buyer agrees to pay up to $20,000 above appraised value, not exceeding the purchase price.  This is helpful for sellers to be assured the offer will stand if the appraisal comes in lower. 

Appraisal gaps can cause a bump in the road when it comes to finalizing a sale of a home, because the appraisal suggests that the actual value of property is less than the agreed upon sale price. It can be a turn off to the buyer.  However, in most cases an appraisal gap does not need to be a deal breaker. You may be able to renegotiate the price with the seller.

What happens if your lender does not require an Appraisal?

This is called a Lender Appraisal Waiver, and this is not the same as an Appraisal Gap Waiver.  This means that the lender is not requiring an appraisal for this borrower…

Once a buyer goes to contract and their loan is submitted into the system. They might not even need to get an appraisal. Typically this is rare and only done only with a quality borrower with a good credit score.

An Appraisal Waiver means the lender is not requiring an appraisal on the home as a condition of your loan.  Either the home value or quality of the borrower parameters meet the lenders internal guidelines.  So the buyer has the option to skip the appraisal process, if they choose or they can go ahead and have a regular appraisal done.  It has both an advantage and a disadvantage.

Appraisal Waiver Advantages:

• It saves the buyer the appraisal fee approximately $500-600.
• It eliminates the appraisal contingency so buyers can close with less obstacles.
• It can be used as leverage with the seller for renegotiations on something else.
• It can speed up the closing process by 1-2 weeks.

Appraisal Waiver Disadvantages: 

• It eliminates the option to renegotiate the purchase price, or cancel the contract.
• You may buy an overpriced home. 

As an Exclusive Buyer Brokerage Office, our job is to have smooth closings with no buyer stress.  We are pro’s at it.  Call us/Text. 727-202-9130.