Understanding The Appraisal Gap

 

Our market is busier than ever.  Properties are going under contract in record time and many sellers are learning to weed through multiple offers to find the most likely to close with the least amount of issues while providing the best return.  In this fast paced market, there are many new tactics buyers are using to make their offer more competitive…maneuvers savvy sellers need to keep abreast of. 

In today’s busy and quickly escalating real estate market, the appraisal gap has become one such area that a buyer can use to stand out among the competition.  So what, exactly, is the appraisal gap?  Simply put, it is the discrepancy that occurs when a buyer's offer is higher than the actual appraised value of the property they want to buy.   It is most commonly experienced by buyers in competitive markets such as our current state in which bidding wars and other aggressive offer tactics have become more and more common.

This discrepancy becomes a problem when a buyer’s ability to purchase a property is dependent on them qualifying for a mortgage that represents a high percent of the entire purchase price  of the home.  Common practice for every mortgage application is the step the lender takes in ordering a home appraisal to ensure they are making a wise investment.   When the appraisal comes in low,  the lender will only loan up to a percent of the appraised value. 

Buyers have four options when this occurs:

  • Make up the difference in cash. 

  • Renegotiate with the seller.  

  • Using the mortgage contingency in the sales contract, back out of the purchase.  

  • The last option is typically less successful and that is to challenge the appraisal or request a new one.  

How can savvy buyers use this appraisal gap to their advantage during the negotiation process?  A relatively new term is being discussed as buyers compete in multiple offer situations where properties are selling far higher than list price…appraisal gap coverage. This is a buyer’s offer to cover the difference between the offer price and the appraised value.  It is written into the purchase offer and includes a specific dollar value the buyer is  willing to contribute over the appraised value to help bridge any potential appraisal gap.

This negotiation strategy is a tactic to help a buyer’s offer be more competitive over other offers.  This contingency would only be triggered should the appraisal come in below the purchase price and would only bridge the gap up to the maximum amount the buyer offered to cover.  For example, if the buyer offered to cover up to $10,000 in an appraisal gap guarantee and the appraised value comes in on target, there is no additional contribution on the buyer’s part.  If it  falls short by $5,000, the buyer would only be required to contribute an additional $5,000.  Lastly, if the appraised value falls short by $12,000, the buyer would only be required to contribute up to the maximum $10,000 in shortfall that was originally offered (not the entire $12,000).

Sellers need to understand new negotiating tactics such as this.  Clearly, it may not only affect an offer on your property, but also the property your buyer may be selling in order to purchase.  Having an experienced Realtor who can investigate all the details of an offer is crucial in today’s hustling market.

It is also important that buyers are well educated on local property values before adding an appraisal gap guarantee to their offer.  Working with someone who has vast knowledge of real estate and local market values is crucial to ensure you make a wise investment.  

Our experienced sales professionals are here to guide both buyers and sellers through the offer and appraisal process.  In this extremely active marketplace where buyers are desperate to stand out, they are educated on all the new negotiating approaches that are being used and can help you determine what is best for your family.