Appraisal Gaps: What to Know

An appraisal gap is a serious obstacle to purchasing a home. An appraisal gap occurs when you make an offer to buy a property, but a professional licensed real estate appraiser says that the house is worth less than the amount you offered. This could affect your desire to buy a house or your ability to borrow enough to afford it.

This guide explains the details on appraisal gaps, as well as what you can do if you encounter this situation when buying a home.

What Is an Appraisal Gap and How Does It Happen?

When you borrow to buy a home, mortgage lenders determine how much you can borrow based on the appraised value of the property. If the home appraisal shows that the value of the home is less than what you are offering, this will affect how much the lender is willing to allow you to finance.

Here's how an appraisal gap happens.

1. Buyer makes an offer: When you find a home you are interested in, you'll make an offer on the house. You'll decide how much to offer based on what you're willing to pay and what you believe the home is worth.
2. Lender appraises the property: Your lender will work with a state-licensed real estate appraiser to determine the property's market value. The appraiser will prepare an appraisal report that shows what the home is worth based on comparable sales and the home's features.
3. Appraised value is lower than the offer price: If the appraised value is lower than the amount you offer, an appraisal gap exists. For example, if you offer to pay $350,000 and the home appraises for $300,000, there is a $50,000 appraisal gap.
4. Difference must be addressed: You'll need to decide how to respond to the fact that the home is worth less than you offered. Your lender will base the amount you can borrow on the lower appraised value, so this means the amount you're approved to borrow to purchase that home may decline.

How to Address Appraisal Gaps

You will need to determine how to resolve the problem created by an appraisal gap. Here are a few options:

• Pay with cash: If you have enough money and you decide it’s the right thing to do for your circumstances, you can pay the difference between the sales price you agreed to and the amount the lender is willing to loan on the property based on the lower appraised value. However, if you do this, you are buying a home at a higher price than its appraised fair market value.
• Renegotiate with the seller: In some cases, you may be able to ask the seller to lower the price. The seller may be willing to make this concession for you, as the appraisal gap is likely to be a problem for the next potential buyer as well.
• Challenge the appraisal: If you believe the appraisal is wrong, you may be able to request a reconsideration of value (ROV). It's helpful if you have some evidence to back up your claim, like recent comparable sales in the area that occurred at a higher price.
• Exit the contract: You may also be able to exit the contract and walk away from the transaction if you have an appraisal gap clause in your offer contract.

Sometimes, you will use multiple methods when you're faced with an appraisal gap. For example, the seller may be willing to reduce the price slightly, and you may have to bring some extra cash to the table as well.

What Is an Appraisal Gap Clause?

When you make an offer to purchase a home, you may want to include an appraisal gap clause in the contract. This states the amount (if any) you are willing to pay out of your pocket to close the appraisal gap. An appraisal gap clause works alongside an appraisal contingency, which is a separate provision that allows you to back out of the deal entirely if the gap exceeds a certain threshold.

If you are willing to make up the difference with an appraisal gap of up to, let’s say $10,000, you could specify that in the agreement. If the home appraises for $5,000 less than your offer price, you'd bring the necessary cash to the table and continue with the purchase. Keep in mind that this cash is in addition to your down payment and closing costs, and, in this scenario, you would be paying more than the home's appraised value.

However, if the home appraises for $25,000 less than your offer price, that gap exceeds the $10,000 limit in your clause. At that point, you could walk away from the deal if you included an appraisal contingency in your offer. Alternatively, the seller may choose to lower the price enough to close the gap and keep the sale on track.

Should You Waive an Appraisal Contingency?

As noted above, an appraisal contingency is the safety net that gives you the right to walk away. When you make an offer on a home sale, waiving the appraisal contingency removes that protection but could make your offer more attractive to the seller. This would mean you agree to complete the purchase no matter how big the appraisal gap is. You are not making the sale contingent on the home appraising for the amount you offer (or even close to it).

You should do this only if you are confident that you can cover any appraisal gap that comes up, or if you are confident that your offered price is equal to or below the market value. This sign of confidence is reassuring for the seller, but it is risky for you if the gap comes back larger than expected.

Final Thoughts: Impact of an Appraisal Gap

If you are faced with an appraisal gap, you still have options. The best thing to do is to talk with your lender and your real estate agent. If you don't yet have a lender, Freedom Mortgage is here to help you start the homebuying process. Reach out today to speak with a mortgage loan professional to get started on your journey to homeownership with a mortgage partner that has helped Americans save money for more than three decades.