What is an Appraisal

Understanding Appraisal Gaps 🏠

An appraisal gap occurs when the value of a property, as determined by a real estate appraiser, is lower than the price agreed upon by the buyer and seller. This means the mortgage lender may not approve a mortgage for the total amount needed to purchase the property, leaving the buyer to pay the difference out of their own pocket. 💵

Say you agreed to buy a house for $500K, but the appraisal totals $450K. That means the appraisal gap is $50K. The lender will only provide a mortgage for the appraised value of $450K, leaving you to come up with an additional $50K yourself to complete the purchase. 🏡💰

In a seller’s market with more buyers than sellers, some sellers may require an appraisal guarantee clause. This clause means that if the appraisal comes in lower than the accepted offer, the buyer will have to pay the difference. 📝

🚨 Appraisal Timing: As soon as the deal goes under contract (aka attorney review has finished), the buyer’s agent should ensure that the buyer is moving forward with the loan process. The lender will want a copy of the finalized contract and rider, along with any other paperwork that the buyer has not yet submitted.  At this time: The lender orders an appraisal.

The lender must then contact one of the agents to coordinate a time and day that works.

The listing agent then must confirm with the homeowner that this day & time works.

Unless the homeowner does it, one of the agents usually has to be there for the appraisal to let the appraiser in.

This report is sent to the lender, usually within a week or two after the inspection. The lender reviews the appraisal report to determine if the property's value supports the loan amount. If the appraised value is lower than the agreed-upon price, the lender may require the buyer and seller to negotiate how to handle the difference (as per the appraisal contingency in the contract).

If the appraisal supports the purchase price and all other loan requirements are met, the lender gives final approval for the loan.

The transaction can then proceed to closing.

Sample Process from Better.com Mortgage:

At Better Mortgage, we make sure the appraisal process is as quick and painless as possible. Here’s what happens at each step:

1. Appraisal ordered: First, we’ll order the appraisal as soon as you lock in your mortgage rate.
2. Appointment scheduled: Within the first several days, the appraiser will contact you (or the homeowner) to schedule a convenient time for the appraisal.
3. Appraisal walkthrough: On the day of the appointment, the appraiser will conduct an onsite evaluation, which includes reviewing the home’s exterior and interior. The onsite inspection usually takes no more than an hour, though it can depend on the size of the house and surrounding property.
4. Findings reported: After the onsite visit, the appraiser will complete and submit their report to the AMC, which will then share the final findings with your lender.
5. Lender review: The lender will look over the appraised property value to ensure the borrower's desired loan amount is in line with the loan’s qualification guidelines.
6. Appraisal finalized: Following their review, the lender may request revisions to the appraisal before it is finalized. These requests are often to correct minor errors, such as the spelling of the borrower’s name, but more extensive changes may be required to ensure the final appraisal meets the lender’s internal standards. For example, the lender may ask the appraiser to comment on whether the home’s appliances are in working order.

Factors That Contribute to Appraisal Gaps 📊

The appraisal gap is a common phenomenon in the real estate market, and several factors can contribute to its occurrence. Let’s explore crucial factors that can lead to appraisal gaps.

Tight Housing Inventory 🏘️

One of the primary factors that can contribute to an appraisal gap is tight housing inventory. When the supply of available homes is limited, buyers may be willing to pay more for a property than its appraised value. In such a situation, the seller has an advantage in negotiations, and the buyer may feel compelled to pay more than the property is worth.

In addition to driving up prices, tight housing inventory can lead to bidding wars among buyers, further increasing the likelihood of an appraisal gap. In a bidding war, buyers may offer more than the appraised value of the property in order to outbid their competitors and secure the home. This can leave the winning bidder with an appraisal gap to bridge.

Furthermore, tight housing inventory can make it difficult for individuals to find a property that meets their needs and budget, causing them to settle for a property that may be overpriced. This can increase the chances of an appraisal gap and leave the buyer in a difficult financial position.

Low Interest Rates 💲

When interest rates are low, it means that more buyers are able to afford homes. As a result, there’s an increase in demand for homes, which can then lead to an increase in sale prices.

Now, in a competitive housing market, things can get pretty intense. Buyers may be willing to pay more for a property than its appraised value to secure a low-interest rate mortgage. They don’t want to miss the opportunity to lock in a great rate, so they’re willing to pay a premium to make it happen.

High Demand 📈

High property demand is another factor contributing to an appraisal gap. With more buyers than available properties, sellers can demand higher home prices. In such a situation, buyers may be willing to pay more than the appraised value of a property to secure the home they want.

Other Factors 🌐

Aside from the ones mentioned above, other factors can also contribute to appraisal gaps. For instance, the location and condition of the property and the accuracy of the appraisal can directly impact the appraised value. Additionally, a lack of comparable sales data in the area can complicate the process of determining the property’s true value.

Why Does the Appraisal Gap Matter?

Simply put, the appraisal gap matters because it can have significant financial implications for homebuyers, homeowners, and sellers. When the appraised value of a property falls short of the purchase price, buyers may have to come up with additional funds to cover the difference or risk losing out on financing.

Homeowners may be unable to refinance or access equity, thus limiting their financial options. Sellers may need to lower their asking price or make costly repairs to attract buyers and close a sale.

But that’s not all. The impact of the appraisal gap goes beyond individual transactions and can contribute to a competitive real estate market with rising home prices. This means that buyers may have to compete for limited inventory and offer more than the appraised value to secure a property within their budget.

💡Tips on How to Bridge the Appraisal Gap

Dealing with an appraisal gap can be stressful, but there are effective ways to bridge the gap and make sure both parties are satisfied with the transaction. Here are some tips to consider.

Consider Alternative Financing Options 💳

If the appraisal value falls short of the purchase price, buyers can explore other financing options, the likes of which include a larger down payment or a higher interest rate. Alternatively, they can seek lending options like a bridge or personal loan.

Negotiate With the Seller 🤝

Negotiating with the seller is another way to address the appraisal gap. Buyers and sellers can work together to find a compromise that works for both parties, such as reducing the purchase price or including additional contingencies.

Price the Property Appropriately 🏷️

Sellers can also avoid appraisal gaps by pricing the property appropriately. This can be achieved by working with an experienced real estate agent that can conduct a comparative market analysis. Then the seller’s agent can determine a realistic and fair price for the property.

Make Repairs and Improvements 🔨

Making necessary repairs and upgrades to the property can also help increase its appraised value. Prioritizing repairs and upgrades before the appraisal can help bridge the gap and make the property more attractive to potential buyers.

Be Realistic 🧠

Lastly, being realistic about the current state of the real estate market is essential in bridging the appraisal gap. In a competitive market with high demand and low inventory, the appraised value may fall short of the purchase price. Understanding these market conditions and having a backup plan can help buyers and sellers navigate the appraisal gap successfully.

Key Takeaways 🗝️

Understanding the appraisal gap is crucial when buying or selling a property in the real estate market. It can impact the number of funds a buyer needs to secure a property, limit a homeowner’s financial options, and/or require a seller to make additional repairs or adjust the asking price.

To bridge the appraisal gap, it’s important to consider alternative financing options, negotiate with the seller, ensure the property is priced appropriately, make repairs and improvements, consider alternative appraisers, and be realistic about the current market conditions. By doing so, buyers, sellers, and homeowners can make knowledgeable decisions and navigate the real estate market like a pro.

Appraisal Gap Options for a Buyer When Offering on a Property:

Example Scenario:

• Offer Price: $700,000
• If Appraised Value: $670,000
• Then Appraisal Gap: $30,000

Option 1: Buyer Covers the Entire Gap 💼

Clause: "In the event that the appraised value comes in below the agreed-upon offer price, the buyer agrees to cover the entire appraisal gap."

Buyer's Responsibility: $30,000

Seller's Responsibility: $0

Pros:

• 🎉 Attractive to Sellers

Cons:

• 💸 Financial Burden: Puts the entire responsibility on the buyer.
• ⚠️ Risk: If the appraisal is significantly lower, it could strain the buyer's finances.

Option 2: Seller Covers the Entire Gap 🏡

Clause: "In the event that the appraised value comes in below the agreed-upon offer price, the seller agrees to reduce the selling price to the appraised value."

Buyer's Responsibility: $0

Seller's Responsibility: $30,000

Pros:

• 🛡️ Protection for Buyer: Reduces financial risk for the buyer.

Cons:

• ❌ Potential Deal Breaker: Seller may refuse, especially if there are higher offers without this clause.

Option 3: Shared Responsibility (e.g. 50/50 Split, 60/40 Split, 75/25 Split, etc.) 🤝

Clause: "In the event that the appraised value comes in below the agreed-upon offer price, the buyer and seller agree to share the responsibility for covering the appraisal gap."

Buyer's Responsibility: e.g. $15,000

Seller's Responsibility: e.g. $15,000

Pros:

• 🧩 Flexibility: Allows for negotiation and can be tailored to the specific situation.
• 💑 Shared Risk: Both parties contribute, potentially making it more palatable.

Cons:

• 🌀 Complexity: Requires clear communication between both parties.
• 🕒 Potential Delays: If an agreement can't be reached quickly, it may delay the closing process.

Option 4: Incremental Buyer Contribution with Maximum Cap 🧢

Clause: "In the event that the appraised value comes in below the agreed-upon offer price, the buyer agrees to cover the appraisal gap according to the following scale, up to a maximum cap set by the buyer.

• Up to $X: Buyer covers 100% of the gap.
• From $X+1 to $Y: Buyer covers 70% of the gap.
• From $Y+1 to $Z: Buyer covers 40% of the gap.
• Over $Z (e.g., buyer's set cap of $30,000): Buyer covers 0% of the gap.

Example Scenario:

• Up to $10,000: Buyer covers 100%.
• $10,001 to $20,000: Buyer covers 70%.
• $20,001 to $30,000: Buyer covers 40%.
• Over $30,000 (or buyer's set cap): Buyer covers 0%.

Pros:

• 🎚️ Customizable: Can be tailored to the buyer's specific financial situation.
• 🤝 Fair Distribution: Aligns the responsibility with the buyer's ability to cover the gap.

Cons:

• 📊 Requires Detailed Calculation: The percentages must be carefully calculated based on the buyer's extra cash.
• 📝 Needs Clear Definition: Both parties must agree on the exact percentages and the definition of "extra cash."

✏️ Note:

• 🗨️ Open communication with the buyer will be essential to determine the appropriate percentages and understand their financial comfort level.
• 📑 This option allows for a flexible approach that can be adapted to different buyers and market conditions.

✏️General Notes:

• 📈 In the current seller's market, especially during multiple offer situations, many buyers are offering with appraisal contingencies to make their offers more attractive.
• 🏆 The highest-priced offer doesn't always win, and cash offers may have an advantage as they don't require an appraisal contingency.
• 📝 Adding an escalation clause can further complicate the offer but may be explained and handled with the assistance of an experienced real estate agent.

These clauses are examples and should be tailored to the specific situation and in consultation with a legal professional or experienced real estate agent. They provide a framework for handling the appraisal gap in different ways, depending on the strategy chosen by the buyer and accepted by the seller.

What is an Appraisal Waiver? Appraisal Waiver Misconceptions | Appraisal Waivers Explained 📝🏠

https://www.youtube.com/watch?v=9rU9_J5oiCE&t=82s

Appraisal Came In LOWER Than Sales Price (WHAT HAPPENS NEXT AND WHAT TO DO) 😲💸

https://www.youtube.com/watch?v=FD1uOIbHVAM

❓FAQs: Appraisal Gap

1. Is appraisal gap coverage a good idea?

   Appraisal gap coverage can be a good idea for homebuyers, considering it provides protection in case the appraised value of the property is lower than the purchase price.

2. How do you explain an appraisal gap?

3. What’s the difference between appraisal gap coverage clause and appraisal contingency?

Do I need an appraisal gap coverage clause?

It might be necessary if you want to avoid dealing with a potential appraisal gap and pay top dollar. The appraisal gap clause specifies the amount you are willing to cover in case there is a difference between the appraisal value and the agreed-upon sales price. The sellers usually require this assurance because an appraisal may come in at a lower value than expected, and they want to ensure the offer will still be valid.

The appraisal gap coverage clause requires you to come to a mutual agreement with the seller regarding the amount you are willing to pay above the appraised value and whether you wish to split the difference.

How do you negotiate an appraisal gap?

To negotiate an appraisal gap, buyers can request a second appraisal, renegotiate the purchase price with the seller, or seek alternative financing options.

What happens when the appraisal is lower than the offer?

When the appraisal is lower than the offer, the buyer may need to bring additional funds to cover the difference or renegotiate the terms of the sale.