What’s an Appraisal Gap?
First off, let’s back the truck up to clarify what an appraisal is, and why you might need one.
An appraisal is a valuation of home value performed by a professional appraiser, often required by a bank or lender, to ensure that the investor/lender is lending funds only up to that appraised value. The appraiser uses a systematic approach based on previous sold comparables, location, square foot, as well as the under contract price and how many offers the listing had. Many variables in the appraisal equation, that boil down to one person’s sole discretion, or judgment of value.
Understanding that the lender/bank is only going to give you a loan based upon the value of the home is the staring point. Next, lets say that the appraiser’s valuation of the home is $10,000 below the purchase/ offer price. Now what? This is that gap. The difference between what the home is worth and the price you offered to pay for the home.
In the strong seller’s market that we are in right now, a seller is going to want certainty that the offer price is the sales price, regardless of the appraisal. This is where you, the buyer comes in…”Hey seller, if needed, I am going to bring up to $x of appraisal gap coverage to give you peace in mind, just in case the appraisal comes in lower than what I am offering to pay you.” Important to know and understand that this is extra cash that you have readily available to bring to the closing table if needed.
For example: List price = $500,000 Offer price = $510,000 Appraisal Gap Coverage = $10,000
To sum it up, an appraisal gap is funds brought by the buyer to cover a shortage between the offer price and the appraisal value. A buyer needs to be prepared to spend that cash out of pocket for some or all of this difference. Best case scenario, the appraisal comes in at or above value.
What happens if the appraisal comes in lower than the appraisal gap coverage? Using our example above, the appraisal values the home at $495,000. In this scenario, the buyer then has the right to object to the appraisal, in which the buyer and seller would begin to negotiate who is going to cover that $5,000 difference between $495k and $500k. The seller may choose to drop the price by $5,000, yet they are going to want to keep the buyer’s $10,000 appraisal gap promise. The buyer’s other options are to refute the appraisal by requesting a rebuttal, or ordering a second appraisal. Lastly, the buyer also has the option to back out of the contract, choosing to no longer purchase the home.
You’d like to offer an appraisal gap, yet don’t have the funds on hand? Don’t fret. Here are a few options:
- Change your down payment amount in your loan in order to free up the cash needed.
- Ask you lender if you would qualify for a down payment assistance program, and if they offer this.
- Ask family or a good friend for a loan. Keep in mind, you may or may not have to use it.
I hope that helps you understand what an appraisal gap is and how it benefits the seller, with the goal to get you under contract, and into your next home!
Still clear as mud? Give me a ring and we will discuss until you are clear.