What to Do with an Appraisal Gap

What to Do with an Appraisal GapAn appraisal gap is a common scenario that happens during many real estate transactions, especially in competitive real estate markets like Southern California. To help you feel confident and prepared for your house hunting journey, we explain what an appraisal gap is, how to respond to it, and what your options are to make sure you're getting a great deal. 

What is an appraisal gap?

An appraisal is a professional assessment of a property's market value conducted by a licensed appraiser. Lenders require appraisals to ensure the loan amount requested by the buyer reflects the actual value of the property. An appraisal gap arises when this appraised value is less than the agreed purchase price.

In other words, an appraisal gap is the difference between the appraised price and the purchase price you offered. You would have a $25,000 appraisal gap if a seller accepted your offer for $750,000 but the home appraised for $725,000.

While an appraisal gap might be perceived as an annoying hiccup, it can actually be beneficial for you as the buyer in some cases. Kenny Raymond with The Raymond International Group explained, "An appraisal gap can be a good thing because it provides an opportunity to reassess the true market value of a property, potentially leading to a more informed purchase decision and better financial stability in the long run."

What causes an appraisal gap?

There are a few things that can lead to an appraisal gap:

  • Market Conditions: In a seller’s market with high demand and low inventory, buyers may offer more than the market value to secure a property, leading to a higher purchase price than the appraised value.
  • Unique Property Features: Unique or customized features might not be adequately reflected in comparable sales, causing a lower appraisal.
  • Rapid Market Changes: In rapidly appreciating markets, recent comparable sales may not fully capture current market values.
  • Appraiser Discrepancies: Different appraisers may have varying opinions on value, and a lack of local market knowledge can result in a lower appraisal.

Why is an appraisal gap a problem?

The problem with an appraisal gap lies with the lender. If you are buying with cash, then you may opt to move forward with the purchase at the agreed price even if the home appraises for less, simply understanding that you'll be paying more than the property is currently worth. For some cash buyers, this is not a problem and worth it because they plan to live in the home long enough that it will all work out. 

However, the majority of buyers are financing the purchase. Lenders won't allow you to borrow past a certain percentage of the value because it puts them at too much risk. If you borrow more than the home is worth and default on the loan, the bank won't have an asset that covers the debt. Your lender will require you to either make a bigger down payment or negotiate a lower purchase price. 

What are my options when there is an appraisal gap?

If you end up with an appraisal gap, you have a few options to consider. 

Renegotiate the Purchase Price

One of the most straightforward solutions is to renegotiate the purchase price. The buyer can request the seller to lower the price to match the appraised value. This option is generally more likely to be successful in a buyer’s market where sellers have less leverage, but we can help advise you on whether it's right in your scenario. 

Increase the Down Payment

You can choose to cover the difference between the appraised value and the purchase price by increasing your down payment. This means you will need to bring additional cash to the closing table. In some cases, buyers do this through gift funds from a family members; if this is your plan, be sure to talk with your lender first to make sure you do it properly and don't cause any issues with the financing. 

Split the Difference

Another option is for the buyer and seller to split the appraisal gap. Both parties agree to cover a portion of the difference, reducing the financial impact on each side. This solution shares the financial burden, maintains goodwill between buyer and seller. It requires negotiation and compromise, so it's not always feasible, but it can be a great solution when both buyer and seller are motivated.

Challenge the Appraisal

If you are confident that the appraisal was lower than is accurate with current market conditions, you can challenge the appraisal by providing additional information to the lender and requesting a review. This could include recent comparable sales that were not considered or specific property features that add value.

Obtain a Second Appraisal

If you believes the appraisal is inaccurate, we can request a second appraisal. While real estate appraisers are trained and certified, their assessment is still subjective. A different appraiser might provide a different valuation, potentially closing or reducing the gap.

Walk Away

If none of the above options are viable, you may choose to walk away from the deal. Most of the time our clients' purchase agreements contain an appraisal contingency, allowing the buyer to back out without losing their earnest money deposit if the property does not appraise for the agreed price.

Negotiate Seller Concessions

You can ask the seller for concessions to offset the appraisal gap, such as covering closing costs or providing a credit for repairs. This can lighten the financial impact of the appraisal gap, though it does not directly address the loan amount.

Finding creative solutions for our clients is our bread and butter. We're ready to help you find the home that's right for you, and our years of experience will benefit you as negotiations, appraisals, inspections, and other details come up. 

We're ready to help you find your ideal property, so contact us any time to find homes for sale near Garden Grove.

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