How to Bridge the Appraisal Gap in Today’s Real Estate Market

Real Estate

How to Bridge the Appraisal Gap in Today’s Real Estate Market
If you’re searching for drama, don’t limit yourself to Netflix. Instead, tune in to the real estate market, where the competition among buyers has never been fiercer. And with homes selling for record highs,1 the appraisal process—historically a standard part of a home purchase—is receiving more attention than ever.
 
That’s because some sellers are finding out the hard way that a strong offer can fizzle quickly when an appraisal comes in below the contract price. Traditionally, the sale of a home is contingent on a satisfactory valuation. But in a rapidly appreciating market, it can be difficult for appraisals to keep pace with rising prices.
 
Thus, many sellers in today’s market favor buyers who are willing to guarantee their full offer price—even if the property appraises for less. For the buyer, that could require a financial leap of faith that the home is a solid investment. It also means they may need to come up with additional cash at closing to cover the gap.
 
Whether you’re a buyer or a seller, it’s never been more important to understand the appraisal process and how it can be impacted by a quickly appreciating and highly competitive housing market. It’s also crucial to work with a skilled real estate agent who can guide you to a successful closing without overpaying (if you’re a buyer) or overcompensating (if you’re a seller). Find out how appraisals work—and in some cases, don’t work—in today’s unique real estate environment.
 
APPRAISAL REQUIREMENTS
 
An appraisal is an objective assessment of a property’s market value performed by an independent authorized appraiser. Mortgage lenders require an appraisal to lower their risk of loss in the event a buyer defaults on their loan. It provides assurance that the home’s value meets or exceeds the amount being lent for its purchase.
 
In most cases, a licensed appraiser will analyze the property’s condition and review the value of comparable properties that have recently sold.Mortgage borrowers are usually expected to pay the cost of an appraisal. These fees are often due upfront and non-refundable.2
 
Appraisal requirements can vary by lender and loan type, and in today’s market in-person appraisal waivers have become much more common. Analysis of the property, the local market, and the buyer’s qualifications will determine whether the appraisal will be waived. Not all properties or buyers will qualify, and not all mortgage lenders will utilize this system.3 If you’re applying for a mortgage, be sure to ask your lender about their specific terms.  
 
If you’re a cash buyer, you may choose—but are not obligated—to order an appraisal.
 
APPRAISALS IN A RAPIDLY SHIFTING MARKET
 
An appraisal contingency is a standard inclusion in a home purchase offer. It enables the buyer to make the closing of the transaction dependent on a satisfactory appraisal wherein the value of the property is at or near the purchase price. This helps to reassure the buyer (and their lender) that they are paying fair market value for the home and allows them to cancel the contract if the appraisal is lower than expected.
 
Low appraisals are not common, but they are more likely to happen in a rapidly appreciating market, like the one we’re experiencing now.4 That’s because appraisers must use comparable sales (commonly referred to as comps) to determine a property’s value. These could include homes that went under contract weeks or even months ago. With home prices rising so quickly,5 today’s comps may be lagging behind the market’s current reality. Thus, the appraiser could be basing their assessment on stale data, resulting in a low valuation.
 
HOW ARE BUYERS AND SELLERS IMPACTED BY A LOW APPRAISAL?
 
When a property appraises for less than the contract price, you end up with an appraisal gap. In a more balanced market, that could be cause for a renegotiation. In today’s market, however, sellers often hold the upper hand.
 
That’s why some buyers are using the potential for an appraisal gap as a way to strengthen their bids. They’re proposing to take on some or all of the risk of a low appraisal by adding gap coverage or a contingency waiver to their offer.
 
Appraisal Gap Coverage – Buyers with some extra cash on hand may opt to add an appraisal gap coverage clause to their offer.It provides an added level of reassurance to the sellers that, in the event of a low appraisal, the buyer is willing and able to cover the gap up to a certain amount.6
 
For example, let’s say a home is listed for $200,000 and the buyers offer $220,000 with $10,000 in appraisal gap coverage. Now, let’s say the property appraises for $205,000. The new purchase price would be $215,000. The buyers would be responsible for paying $10,000 of that in cash directly to the seller because, in most cases, mortgage companies won’t include appraisal gap coverage in a home loan.6
 
Waiving The Appraisal Contingency – Some buyers with a higher risk tolerance—and the financial means—may be willing to waive the appraisal contingency altogether. However, this strategy isn’t for everyone and must be considered on a case-by-case basis.
 
It’s important to remember that waiving an appraisal contingency can leave a buyer vulnerable if the appraisal comes back much lower than the contract price. Without an appraisal contingency, a buyer will be obligated to cover the difference or be forced to walk away from the transaction and relinquish their earnest money deposit to the sellers.7
 
It’s vital that both buyers and sellers understand the benefits and risks involved with these and other competitive tactics that are becoming more commonplace in today’s market. We can help you chart the best course of action given your individual circumstances.
 
DON’T WAIVE YOUR RIGHT TO THE BEST REPRESENTATION
 
There’s never been a market quite like this one before. That’s why you need a master negotiator on your side who has the skills, instincts, and experience to get the deal done…no matter what surprises may pop up along the way. If you’re a buyer, we can help you compete in this unprecedented market—without getting steamrolled. And if you’re a seller, we know how to get top dollar for your home while minimizing hassle and stress. Contact us today to schedule a complimentary consultation.
 
Sources:
 
  1. Wall Street Journal –
  2. Rocket Mortgage –
  3. Money –
  4. Bigger Pockets –
  5. Washington Post –

Recent Blog Posts

Stay up to date on the latest real estate trends.

The Best Time to Sell Your Home

and the home selling timeline

Fresh Year, Fresh Start: Cleaning Out Your Home for the New Year

Many of us could not wait to close the door on 2020 and usher in the new year– and all the positive karma we hope comes with it! As you look forward to 2021 you may ha… Read more

Seller

Seller FAQs

If you have a home to sell, you’re probably excited to get the process started. There are many things you need to consider when selling your property, and it’s hard no… Read more

Real Estate

Pros and Cons of Selling During the Holidays

If you are thinking about listing your home this fall, you might be concerned about showing it, and possibly having to move, over the holiday season. The holidays are … Read more

Considering Short Term Rentals?

Considering Short-Term Rentals? Short-term rentals can be a highly lucrative investment and a fun way to make money. Some of the advantages to managing a short-term re… Read more

8 Reasons Why Real Estate is the Best Investment

Real estate has long been considered a solid investment for many reasons. It is a relatively safe and easy way for people to build wealth beginning with a small amount… Read more

7 Tips for Saying Goodbye to Sentimental Belongings

When I work with clients who are downsizing to a smaller home, one of the hardest chores they face is letting go of sentimental belongings they no longer have room for… Read more

Home Renovations Q&A

Renovating Your Home? Check Our FAQ’s! How do I pick a contractor? Ideally, you want to build the same kind of relationship with your contractor as you do with your re… Read more

Is it Smart to Refinance?

Your home mortgage is an important investment in your future, and a mortgage refinance can be a smart move to help you manage your investments when used under the righ… Read more

Let's Talk

You’ve got questions and we can’t wait to answer them.