These days, more than ever, it is vital for homeowners to educate themselves on all manner of terms and lingo surrounding the purchasing experience. One such term that you may not be familiar with is, “appraisal gap.” Below you will discover what an appraisal gap is and what you need to know in order to successfully navigate a home purchase in the event of an appraisal gap.
An appraisal gap is simply the difference or “gap” between what an appraiser values a home’s fair market value at and what a home buyer agrees to pay for the home. For example, a home may appraise at $329,000 but because of other market factors, you may be willing to pay $350,000.
In 2022, the real estate market continues to show signs of inflation. Due to the low supply of existing homes, as well as cost and supply chain issues of new building materials, there is currently a high demand for available homes. This phenomenon naturally puts a higher demand on homes for sale, which in turn drives up the purchase price. When purchase prices are suddenly sky-rocketing, many home buyers find themselves in a competitive market where they are having to act quickly and often offer above the asking price on a home they wish to purchase.
In many cases, the home price has become so inflated that it is exceeding the home’s actual, fair-market, appraised value. It is important to understand the implications of this gap between appraised value and purchase price. While some sellers write into the contract what is known as an appraisal guarantee clause– a binding agreement that causes the buyer to cover the difference, this isn’t the only workaround when there is an appraisal gap.
According to Rocket Mortgage, there are essentially four options on how to handle this situation:
The first option is for the buyer to pay the difference. If the home appraises below the agreed upon purchase price, buyers must cover the difference, often in cash, at the time of the real estate closing. Many mortgage lenders will not lend buyers an amount above the appraisal value. This means home buyers must have the cash on hand to cover the difference. In such a heavy seller’s market, it is important to know this and plan accordingly with savings reserves, down payment amounts, and by researching lending options.
Secondly, buyers may try to renegotiate the offer with the seller. This option can be a huge risk especially if there have been multiple offers on the property. Ideally, buyers would ask the seller to amend the sales price to the appraisal amount. In some cases, sellers may be willing to do this and then split the difference of the gap amount– leaving both buyer and seller to each pay half. This scenario is harder to come by in markets like the current one, especially if there are multiple offers on the property.
Another alternative would be for the buyer to try to dispute the appraisal in writing. This can be a time-consuming process, but in this scenario, the buyer would attempt to prove that the appraisal was inaccurate based on mistakes in the report, not identifying upgrades to the home, or not properly evaluating comparable homes in the area against the property in question. Going this route requires lots of legwork, documentation, and patience.
Finally, if all else fails, buyers may simply walk away from the sale. Whether it is a cash problem, a renegotiation problem, or an appraisal dispute problem, it might be a sign that you just aren’t meant to have this particular house. Paying a lot more than a home is worth is a personal decision based on a buyer’s comfort level with risk. If you are planning to walk away from the sale, be sure your buyer’s agent has included an appraisal contingency in your offer so that you can retain your earnest money.