Appraisal gaps are an unfortunate side effect in a competitive market in real estate.
Consistent home demand can push prices up higher than the appraised value. When this happens, there may be a gap between the offer you made on the home and the actual value.
What's in this article?
Read on to learn how to deal with an appraisal gap, including why they happen and your options for moving forward with the home sale.
What happens when a home appraisal comes back lower than the offer amount?
A real estate appraisal is an evaluation of a property’s fair market value, based on comparable home sales and the condition of the home.
If a buyer agrees to pay a certain amount for a home and the appraiser comes back with a lower value, you have an appraisal gap.
Appraisal gaps are more common in competitive housing markets because home prices are rising quickly and because recent, comparable sales may not accurately reflect the current value.
Additionally, when buyer demand is high and inventory can’t keep up, buyers may be forced to overbid to win a home.
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What does an appraisal gap mean for me as a buyer?
An appraisal gap can potentially cost the buyer thousands of dollars.
A mortgage lender can only lend up to the fair market value of the home. If the offer price is higher than the appraised value, the buyer has to cover the remaining gap.
Here’s an example of an appraisal gap:
Imagine you make an offer on a home for $265,000 with a 20% down payment.
A 20% down payment would be $53,000, so the lender agrees to a $212,000 loan amount.
Now imagine the appraisal comes back at $240,000. The appraisal gap is the difference between the $265,000 you agreed to pay, and the $240,000 appraised value.
The gap of $25,000 plus the new down payment amount—$48,000—means your new upfront cost is $73,000.
The new amount is $20,000 more than what you had originally planned to pay.
What are my options in handling an appraisal gap?
In a more balanced housing market, buyers usually include an appraisal contingency in their offer that allows them to back out of the sale if the home doesn’t appraise for the amount of the offer.
The appraisal contingency is often waived in a competitive, seller’s market to make the offer more appealing to a seller.
If you have an appraisal contingency in your offer, you have the option to renegotiate with the seller.
Renegotiating may look like one of the following options:
- Asking the seller to lower the purchase price to the appraised value
- Asking the seller to split the gap amount
The buyer also can choose to walk away from the sale with their full earnest money deposit if renegotiation fails.
Let’s take a look at the buyer’s options if they do not have an appraisal contingency.
Cover the appraisal gap
The first option a buyer has is to simply cover the appraisal gap by paying the difference in cash.
In the example above, this means you’ll pay a total of $73,000.
You also can ask your lender if you can adjust your down payment amount to use more of that cash to cover the gap.
Dispute the appraisal
Only dispute the appraisal if you have clear evidence that the appraiser made a mistake.
If you don’t, you won’t have much luck.
Back out of the sale
If you can’t cover the gap or dispute the appraisal, you’ll have to walk away from the home.
Unfortunately, if you don’t have an appraisal contingency, you will not get your earnest money deposit back either.
However, not all hope is lost. With the right lender, buyers can use an appraisal gap coverage clause, which is another option to cover the appraisal gap.
How can I protect myself from losing the house I want?
If you’re unable to cover the appraisal gap, it’s very likely you’ll lose the home you want.
That’s why it’s important to shop around for the right lender who can offer you protection in tricky seller’s market scenarios.
Compass Mortgage offers buyers an appraisal gap coverage clause through our Get Committed loan commitment program.
Our appraisal gap coverage clause allows borrowers to pay private mortgage insurance (PMI) upfront instead of paying the full appraisal gap amount.
Borrowers generally pay PMI if they put down less than 20% on a home.
If you use our appraisal gap coverage, you can keep your original down payment amount by paying extra each month or paying an upfront lump sum, rather than covering the full gap in cash.
In the example mentioned earlier, the loan amount would remain $212,000, and instead of paying an extra $20,000 to cover the gap, the buyer would just need to pay the $53,000 down payment, plus $1,728 for the cost of mortgage insurance.
(The cost of mortgage insurance can vary by the borrower.)
Get Committed+ with appraisal gap coverage
Compass Mortgage’s Get Committed program provides borrowers with a fully underwritten loan commitment and locks in the interest rate before they even find the home they want to buy.
A loan commitment essentially has the power of a cash offer and proves to the seller that you’re fully approved financially.
Appraisal gap coverage clause from Compass Mortgage takes things a step further. It’s written into the purchase contract and states that you, the buyer, will pay the difference between the contract price and appraised value up to a certain amount.
As a result, the buyer and seller can reach an agreement that if an appraisal gap occurs, the seller has accepted a certain amount rather than allowing the deal to fall through— which would happen with a contingency.
Apply with the Compass Mortgage team today. We promise to be your advocate and partner through every step, with a process backed by the convenience and power of technology.
Photo by Christina Morillo