What Buyers and Sellers Need To Know About the Appraisal Gap

December 29, 2021
Last updated:
December 30, 2021
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When you find a home you love, you’re eager to make an offer and get the homebuying process started. Your lender will require an appraisal to determine the value of the home compared to its list price. This can be a nail biting moment — what happens if you wind up facing an appraisal gap?

Unless you’re paying cash, a home appraisal is a must. The results of the appraisal can impact whether or not you’re able to move forward with your home purchase. Here’s what you need to know about the dreaded appraisal gap.

What is an appraisal, and what’s involved in the process?

What is an Appraisal?

A home appraisal is conducted by a professional appraiser who provides an unbiased assessment of a home’s value. Appraisals are used both for original mortgages and refinances.

An appraiser uses a standard protocol to arrive at the value of a home based on current market conditions. The value that an appraiser arrives at is used to determine whether or not the sale price of the home is accurate based on the home’s condition, features, and location. For refinances, a home appraisal is used so that lenders can be certain that they’re not lending any more money than what a home is worth.

In the event that the borrower defaults on the mortgage, the home could go into foreclosure. This means the lender would have to sell the property to recoup the loaned funds. A home appraisal can help lenders avoid this situation by providing an accurate assessment of a home’s value.

How is a Home’s Value Determined?

There are several factors that determine how much a home is valued at, including the following:

  • Location. Where the home is located plays a key role in how much it’s worth, as some areas are much more desirable than others.
  • Square footage. The size of the home matters in a home appraisal. Generally speaking, a larger home is valued higher than a smaller home, considering all other factors.
  • Number of bedrooms and bathrooms. Homes with more bedrooms and bathrooms are typically valued higher.
  • Improvements. Certain renovations and upgrades can increase the value of a home, such as a kitchen renovation or bathroom update.
  • Age. The age of the home will be factored into the home appraisal and assessed against all other factors involved.
  • Construction materials. Better quality materials will make a home more valuable.
  • Style. Outdated properties may not be valued as high as homes that are finished according to today’s modern style.
  • Current housing market. The temperature of the local real estate market always plays a role in what a home is worth.

What is the Real Estate Appraisal Gap?

It’s not uncommon for homes to sell for well over their listing prices, especially in hot real estate markets. Yet not only are buyers paying prices over listing price, they’re also paying prices that are higher than what other comparable homes in the area have sold for.

In other words, homes are selling for prices higher than what the market data appraisers have available to them can support. The difference between the sale price and the appraised value of the home is what’s known as ‘the appraisal gap’.

Why Does an Appraisal Gap Happen?

Hot real estate markets are typically synonymous with bidding wars. Buyers who fall in love with a home and see that other buyers also have their eyes on it may be willing to pay more than what a home is worth to secure that home.

Even if a buyer is financially capable of getting approved for a very high loan amount to finance an expensive home purchase, things can get complicated if a lender finds out the home is not worth what the buyer agreed to pay.

Appraisal Gap Contingencies and Guarantees

Appraisal gaps can be a bit risky for buyers if the appraiser decides that the appraisal is too low compared to the agreed purchase price. That said, buyers can protect themselves with the appropriate contingencies in their offers.

What is an Appraisal Contingency?

An appraisal contingency clause can be added to a real estate contract to give buyers the chance to back out of the deal if the home is appraised for less than what the buyer initially agreed to pay for it. In this case, the buyer won’t lose their earnest money deposit.

These contingencies are often used by buyers who are using a mortgage to finance the purchase of a home, or if home prices in the area are volatile.

An appraisal contingency clause in an offer lets sellers know that the buyer will have the home appraised as part of their agreement to purchase.

Appraisal Gap Strategy

In a competitive market buyers that include strict appraisal contingencies may have a difficult time getting an offer accepted on a competitive home. An Appraisal Gap Strategy can allow you to minimize the appraisal contingencies you include with your offer.

This is done by determining your qualification and loan options prior to making an offer with the assumption that the appraisal may come in low. If you know you will qualify and you’re comfortable with the adjusted loan parameters that come as a result of a lower appraised value, you have the ability to make a more competitive offer without increasing your risk.

In many situations the new loan parameters can be structured with minimal impact to your monthly payment and cash due at closing.

How to Deal With a Low Home Appraisal Value

If you make an offer on a home at a price that’s far above what the home is ultimately appraised for, you have some options:

Invoke an appraisal contingency clause and walk away

As long as you have an appraisal contingency clause built into your offer, you’ll have the opportunity to back out of the deal without repercussions.

Accept any financial consequences

If you do not insert an appraisal contingency clause in your offer or waive it, you can still walk away from the deal. However, you’ll likely lose your earnest money deposit.

Negotiate with the seller to drop the asking price

You can use the home appraisal as negotiating power with the seller to request a lower price for the home.

Restructure your loan

If you are putting 20% down on a home but the appraisal comes in low you can adjust the structure of your loan to accommodate the low appraised value. This will mean the terms of your loan will change and you will likely trigger private mortgage insurance.

Come up with the difference

If you’re able to, make up the difference between the appraised value of the home and sales price in cash upfront before closing on the transaction.

Dispute the appraisal

Ask to have the appraisal redone, either by the same appraiser (who may have made some mistakes) or by another appraiser. Keep in mind that you may have to pay for this second appraisal out-of-pocket.

Today’s Mortgage Rates

Why Choose Sammamish Mortgage?

At Sammamish Mortgage, we support you through the entire home buying process, from getting you preapproved so you come to sellers with a strong offer to helping you navigate the appraisal and closing steps of your home purchase.

Sammamish Mortgage has been in business since 1992, and has assisted many homebuyers in the Pacific Northwest. If you are looking for mortgage financing in Washington State, we can help you get preapproved. Sammamish Mortgage offers mortgage programs in Colorado, Idaho, Oregon, and Washington.

Contact a loan officer if you have any mortgage-related questions or concerns. If you are ready to move forward, you can view rates, obtain a customized instant rate quote, or apply instantly directly from our website.

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