The Short Answer
An appraisal gap is the difference between the appraised value of a home, and the agreed-upon price between the buyer and the seller. Whether the appraised value is higher or lower than the purchase price that has been agreed on in the offer, this can be a stumbling block in a real estate transaction.
Without an appraisal gap clause or an appraisal contingency in the contract, buyers have a few options that include, exiting the deal if they can, renegotiating the price with the seller, paying the difference if the appraised value is lower, and getting the appraisal reviewed or re-done. Appraisal gap clauses are a vital consideration for buyers and sellers, to avoid any issues in the event of an appraisal gap.
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What Is An Appraisal Gap?
In the world of real estate, an appraisal gap is the difference between the home appraisal value (which is determined by a licensed professional appraiser) and the agreed upon purchase price. Typically, an appraisal gap can cause problems in a real estate deal when the appraised value falls short of the short of the agreed upon purchase price.
Appraisal gaps are likely to occur when home prices in the real estate market are rising quickly. In this scenario, a low appraisal is likely to occur, which creates a difference between the appraised home value and the purchase price because home prices are increasing rapidly. However, appraisal gaps can happen under any market conditions, so it’s important to know how to handle this situation.
Can You Get Appraisal Gap Coverage?
For buyers who would like to make sure they are covered, in the event of an appraisal gap occurring, a feasible financial solution is to use appraisal gap coverage. Essentially, appraisal gap coverage is an insurance policy or safety net to help bridge the gap between the appraised value of a property and the agreed upon purchase price. Appraisal gap coverage can provide valuable protection for both the buyer and the seller in a real estate transaction.
Appraisal Gap Examples
Here are a few examples of an appraisal gap in a real estate transaction.
Example 1
If a buyer has made an offer on a home of $350,000, and the home undergoes an appraisal by a licensed professional who determines that the market value is $300,000, then the appraisal gap is $50,000. The buyer then chooses to attempt renegotiating with the seller on the offer, to find a middle ground and lower their offer based on the appraisal. If the seller comes to an agreement with the buyer in the negotiation, then the deal can continue. If not, the buyer can exit the deal or request a new appraisal.
Example 2
If a buyer makes an offer of $200,000 on a home and the appraised value is $220,000, and there is an appraisal gap clause, then the buyer will need to fork out the extra $20,000. The appraisal gap clause essentially requires the buyer to pay the difference. This can be done using cash or appraisal gap coverage, if a buyer has secured this coverage.
Example 3
Let’s say a buyer makes an offer on a property that is $300,000 but the appraised value is only $270,000, this means that the appraisal gap is $30,000. If the buyer does not want to pay more than the appraised value, they can dispute the appraisal. This would entail a reconsideration of the value of the home, however there will need to be evidence of this, such as features that haven’t been included, or not enough comparable sales being included. Buyers can also ask for a new appraisal to be done, with a different appraiser.
What To Do If The Appraisal Is Less Than Your Offer
If the professional appraiser determines that the market value of a home is less than the offer you are making to purchase the home, there are a few ways you can move forward with the transaction.
Option 1: Pay The Difference
One option that you can do is pay the difference between your offer and the property’s appraisal amount. You can do this using cash, or another payment option such as appraisal gap coverage. In some cases, sellers will have an appraisal guarantee clause which requires the buyer to pay the difference when the appraisal is lower than the offer, in which case the buyer will only have one option.
Option 2: Exit The Deal
For buyers who aren’t interested in paying more for a property than the appraised value, even though they made a higher offer, and sellers who won’t accept any less than the original offer, the most logical option may be for the buyer to exit the deal. Walking away from a deal to look for another property purchase where the offer is closer to the appraised value can be a quicker solution to a stalemate, in this scenario. However, buyers might face penalties for doing this.
As such, it’s important for a buyer to use an appraisal contingency in the original deal. This contingency provides the buyer with an exit strategy if the appraisal reveals a significant difference between the offered price and the appraised value. The appraisal contingency allows the buyer to renegotiate the purchase price, request that the seller make up the difference, or, if an agreement cannot be reached, withdraw from the transaction without facing penalties.
Option 3: Renegotiate The Price
Once a seller and buyer have determined that there is an appraisal gap where the appraisal value is less than the offer that was made, a buyer can renegotiate the price with the seller. In some instances, a middle ground can be reached if the seller is willing to accept a lower offer and the buyer is willing to pay a bit more than the appraised value. In other cases, the seller is not willing to renegotiate on the offer that was already made, and the buyer will need to decide if they’re willing to pay the difference or not.
Option 4: Review The Appraisal
A buyer can opt to get the appraisal reviewed if they believe that there are certain elements of the appraisal that could be re-looked, which may raise the value of the property. For example, features that have been missed, or comparable sales that haven’t been adequately accounted for. An appraisal review will require a letter stating why you feel the appraisal is not correct, with proof attached.
Option 5: Request New Appraisal
Buyers can request a new appraisal, for appraised values that are much lower than the offer they have made. In this case, they will need to come to an agreement with the seller to get the property appraised again, potentially by a different appraiser.
Final Tips For Dealing With Appraisal Gaps
Appraisal gaps can be navigated easily with an appraisal gap coverage clause. An appraisal gap coverage clause is a provision in the real estate contract that outlines how an appraisal gap will be dealt with. This will be triggered by the appraisal value being either lower or higher than the offer that the buyer has made.
Both an appraisal contingency and an appraisal gap clause are useful to add into a real estate contract. An appraisal contingency in the sale agreement is important for buyers who may need to exit the deal and choose not to pay the difference. An appraisal gap clause is also important, so that the seller is also protected in the event of an appraisal gap.
An appraisal gap is a common occurrence in real estate transactions, so it’s important for buyers and sellers to plan ahead for how they will manage the situation. Appraisal gap clauses are the easiest way to do this.