Appraisals are a key part of every real estate transaction. Regardless of market conditions, the appraised value must support the contract price for most financed purchases to move forward. When there’s a gap between the two, it can impact both buyers and sellers. Understanding how appraisals work can help you avoid surprises and keep your transaction on track. For a current snapshot of pricing trends and market conditions, see my latest market update.
That’s because some sellers discover 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 when market conditions are shifting, it can be difficult for appraisals to keep pace.
Many sellers 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 in a variety of market conditions. 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 where they can sometimes fall short, in a constantly changing 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 they are lending 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.
Appraisal requirements can vary by lender and loan type, and in-person appraisal waivers have become much more common. The lender reviews the property, local market and buyer’s qualifications to determine if they will waive the in-person appraisal requirement. Not all properties or buyers will qualify, and not all mortgage lenders will utilize this system. 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 Changing Market Conditions
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. It also allows them to cancel the contract if the appraisal is lower than expected.
Low appraisals are not common, but they are more likely when market conditions shift. That’s because appraisers must use comparable sales (commonly referred to as comps) to determine a property’s value. These will include homes that went under contract months ago. Because of this, the comps are often lagging behind the market’s current reality. Thus, the appraiser could be basing their assessment on stale data. This stale data could result in a low or even a high 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 balanced market, that could be cause for a renegotiation. When the market tips in favor of sellers, they usually hold the upper hand.
That’s why in competitive markets some buyers use the potential for an appraisal gap as a way to strengthen their bids. They 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.
For example, let’s say a home is listed for $600,000. The buyers offer $650,000 with $25,000 in appraisal gap coverage. Now, let’s say the property appraises for $625,000. Even though the home appraised for $25,000 less than the purchase price, the buyers would be responsible for making up that gap of $25,000 in cash. This is because the loan will be based on the lower, appraisal value rather than the higher purchase price. In certain situations, a buyer could also increase the loan-to-value amount they are borrowing if they and the home qualify.
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 must cover the difference or be forced to walk away from the transaction and possibly relinquish their earnest money deposit to the seller.
It’s vital that both buyers and sellers understand the benefits and risks involved with these and other competitive tactics that have become more commonplace. I can help you chart the best course of action for your individual circumstances.
Don’t Waive Your Right to the Best Representation
Real estate transactions can present unexpected challenges, and having the right guidance can make a significant difference in the outcome. 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, I can help you compete effectively without getting steamrolled. And if you’re a seller, I know how to get top dollar for your home while minimizing hassle and stress. Contact me today to schedule a complimentary consultation.