Appraisal Gap: How Home Buyers Can Deal With a Low Appraisal

Sometimes when you're trying to buy a home, your mortgage lender's appraiser says the house is worth less than you agreed to pay. This is known as an appraisal gap or a low appraisal. You may have to pay the difference in cash or renegotiate with the seller to keep the deal alive.

An appraisal gap resulting from a low appraisal can happen under any market conditions. It's more likely to occur while home prices are rising rapidly, but it can happen even when home values are falling.

» MORE: How a home appraisal works

What happens when the appraisal is lower than the offer?

When facing an appraisal gap, you have the following options:

• Pay the difference in cash between the appraised value and the amount of your offer.

• Walk away, if you have an appraisal contingency in your purchase contract.

• Renegotiate with the seller.

• Request a review of the appraisal if you find inaccuracies.

• Apply with another lender in hopes that it will hire an appraiser who values the property in your favor.

This article is mostly about that first option — paying the difference. The next option — walking away — is the least risky. Like a little black dress, it will forever remain in style.

The last three options for dealing with an appraisal gap can save money and preserve the deal, but might be impractical when home buyers outnumber sellers. This imbalance, called a seller's market, leaves home buyers with a weak negotiating posture.

» MORE: When you’re concerned bias is affecting an appraisal

How to deal with a low appraisal

Pay the difference in cash

If the seller won't reduce the price, it’s going to take a bigger down payment than perhaps you had expected — enough to cover the difference between the appraised value and the price.

A bigger down payment would be necessary because mortgage lenders won’t let you borrow more than the home is worth. To confirm whether the property is worth what you offered, the lender hires an independent third party to assess the property's value. The appraiser is that third party. To home buyers' chagrin, appraisers sometimes conclude that properties are worth less than the offer.

Cash buyers don't have lenders peering over their shoulders, so they don't need appraisals, says Chuck Vander Stelt, a real estate agent in Valparaiso, Indiana, and founder of quadwalls.com. The ability to buy without an appraisal gives cash buyers an advantage in a competitive market.

Most buyers need mortgages, though. The appraisal is important because the loan amount is based on the appraised value. If the property appraises for $300,000 and the loan requires a 5% down payment, then the maximum loan size will be 95% of the appraised value, or $285,000.

But what if you had made an offer of $330,000 for a house that appraises for $300,000? The lender will advance you $285,000 based on the $300,000 appraisal. That's $45,000 less than the price, and you'll have to bring every penny of that amount to closing. This situation can be stressful if you expected to make a 5% down payment of $16,500, only to find out that you'll have to scrounge up another $28,500 because of the low appraisal.

Renegotiate with the seller

When the purchase contract has an appraisal contingency and the appraisal is low, you can try negotiating with the seller to reduce the price. You can ask the seller to cut the price to the appraised value or to split the difference. The seller may agree, or make a counteroffer, or turn down your offer and accept the next-best offer.

Other ways to overcome an appraisal gap

You can request a review of the appraisal if you find inaccuracies in the appraiser's report. Your agent can help with the research and paperwork. Or you could apply for a mortgage with another lender and hope for a more favorable appraisal. The problem with these approaches is that they take time. An impatient seller might throw out your offer and accept another.

Lastly, if you have an appraisal contingency you can walk away and make an offer on another property.

Appraisal gap coverage limits your exposure

A typical home purchase contract has an appraisal contingency: wording that says the buyer can call off the deal if the property appraises for lower than the buyer offered. But in hot real estate markets, where buyers outnumber sellers, some buyers waive the appraisal contingency. These buyers either pay cash for the home or gamble that they have money to pay the difference between the appraised value and the price, however much that may be.

There’s another option: an appraisal gap coverage clause. Rather than having a walk-away appraisal contingency or none at all, your agent can write a  clause in the purchase contract that says you will pay the difference between the appraised value and the contract price, up to an amount that you choose.

Take the example above, with a $30,000 difference between the purchase price and the appraised value:

• If you had offered to cover an appraisal gap up to $30,000, you would proceed with the purchase.

• But if you had offered to cover an appraisal gap up to $20,000, you would be entitled to withdraw your offer and get your deposit back. That's because the difference between the offered price and the appraised value is greater than the $20,000 appraisal gap coverage.

Your offer needs to be believable, especially if there’s a bidding war on the property. You're more likely to succeed if you include financial documentation with the offer.

"Not only should you be turning in your preapproval letter, you should also be turning in a proof of funds demonstrating you've got those funds to cover that appraisal gap," Vander Stelt says. This will make your offer look more credible than competing offers without documentation.

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