Appraisal gaps are a common issue in a competitive housing market and can be devastating to home buyers at a point when they are so close to the finish line.
This dreaded gap occurs when a home is appraised for less than the purchase price to which the buyer and seller have agreed.
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Buyers are then left with three options: Do they renegotiate, pay more or walk away?
Let’s dig into the home appraisal process, what to do if there’s an appraisal gap and how to connect with a lender who offers the option of appraisal gap coverage.
What is an appraisal gap?
When a buyer finds a home they love and makes an offer, they usually need an appraisal to confirm the home’s value and to ensure it matches the sales price.
The appraisal is beneficial for both the buyer and lender because the buyer doesn’t want to pay more than what the home is worth, and the lender doesn’t want to lend more than what the home is worth.
Many buyers choose to include an appraisal contingency in their offer, which allows them to negotiate the purchase price or to back out of the deal entirely if the home appraises differently than expected.
A licensed appraiser will go to the home and evaluate it based on a number of factors, including the condition of the home and comparable home sales in the area.
Based on these factors, the appraiser will determine the home’s current market value.
If the home’s value is lower than the contracted purchase price the buyer and seller agreed to, the result is an appraisal gap.
Appraisal gap example
Here’s an example: You agree to purchase a home for $300,000 with a 20% down payment which would be $60,000. The lender agrees to a $240,000 loan amount.
The appraisal, however, comes in at $280,000, creating a gap of $20,000 between the appraisal and the price upon which you and the seller have agreed. While a 20% down payment on $280,000 would be $56,000, the $20,000 gap would mean your up-front cost would surge to $76,000.
Understandably, it can be difficult for buyers to come up with an additional $16,000 to cover the gap.
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How likely is an appraisal gap?
Appraisal gaps are much more of an issue in a hot real estate market for a few reasons:
- Prospective buyers are competing for fewer homes, so they often will bid over the asking price in order to win the bid.
- Prospective buyers often will waive any appraisal contingencies or offer appraisal guarantees stating they will make up the difference if the appraisal is low.
In these instances, it is the buyer’s responsibility to fill in the gap. However, buyers have other options if an appraisal gap occurs.
What should I do if the appraisal is lower than my offer?
Buyers have three main options if the appraisal comes back lower than the offer: renegotiate, pay the difference or walk away from the sale.
However, if you are working with a lender like Compass Mortgage which offers an appraisal gap coverage alternative, you may have an added option.
Let’s take a look at each choice.
Renegotiate with the seller
Renegotiating is a possibility if the buyer has an appraisal contingency in the purchase contract and may mean asking the seller to either lower the price or split the difference between the sale price and the appraisal.
An appraisal contingency could also mean that if the home fails to appraise for the purchase price agreed to by the seller and the buyer, the buyer can simply walk away from the sale with all of their earnest money (or deposit) intact.
However, appraisal contingencies aren’t usually recommended in a competitive market because the seller can easily move on to another offer, no matter the implications for the buyer.
Make up the difference in cash
If you don’t have an appraisal contingency, you’ll be left to pay the difference in cash.
This will be added to the down payment amount to which you have agreed, plus the difference between the sales price and the appraised value.
Walk away from the home
Many buyers understandably can’t fork over the extra cash, depending on how far off the appraisal was.
In this case, if you have no appraisal contingency and can’t afford to pay the difference, you may have to walk away from the home. And, you may also have to give up your earnest money!
Find a lender who offers an appraisal gap coverage clause
Buyers have one more option, depending on their lender.
Some lenders offer an appraisal gap coverage clause, which provides borrowers with another way to bridge the appraisal gap.
Compass Mortgage offers this alternative to borrowers by allowing them to pay private mortgage insurance (PMI) up front instead of paying the full difference from the appraisal amount.
With this option, borrowers can keep their original down payment by paying extra each month or in a lump sum, instead of coming up with the full difference in cash.
What is appraisal gap coverage?
Appraisal gap coverage is a policy written into a purchase contract that allows the buyer to state they will pay the difference between the contract price and appraised value up to a certain amount.
This way, the buyer and seller can agree that, in the case of an appraisal gap, there’s an accepted amount the seller will receive instead of having the entire deal fall through (as in the case of a contingency).
By purchasing up-front PMI, the loan amount can remain the same for the buyer.
In the appraisal gap example mentioned earlier, the loan amount would remain $240,000, and instead of paying an extra $16,000 to cover the gap, the buyer would just need to pay the $60,000 down payment, plus $1,728 for the cost of mortgage insurance.
(The cost of mortgage insurance can vary by borrower.)
Apply for a loan today with Compass Mortgage
The Compass Mortgage team is determined to help our clients win their bids.
Through our Get Committed® loan commitment program, we are able to offer appraisal gap coverage as an alternative to traditional gap options.
This program allows us to instill confidence in our clients by showing that we can get you in your dream home, no matter the obstacles.
If you’re ready to confidently get started with the lending process, apply today.
We care about you and your financing needs and promise to be your partner and advocate through every step.
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