When you enter into a purchase agreement on a home, your mortgage lender will hire a licensed appraiser to assess its value. The independent appraisal assures the lender that the property is worth what you offered to pay for it. Sometimes, though, the value may come in low, and this “appraisal gap” can cause closing delays, loss of deposit money, or put the brakes on the deal altogether.
In 2024, appraisal issues delayed 5% of closings, according to the National Association of Realtors. Bidding wars, unique properties, and incomplete or inaccurate property information are some of the reasons a home’s value might be lower than expected. Fortunately, there are many steps that buyers and sellers can take, working alongside their real estate agents, to overcome appraisal issues.
Understanding the Appraisal Process
After the seller accepts your offer, your lender will schedule a home appraisal to get an objective opinion of the home’s value. A licensed appraiser will consider several factors when writing the appraisal report, including:
- Property condition: The appraiser visits the home and notes its condition, upgrades and features. They’ll also take measurements to verify the home’s square footage.
- Comparative market analysis (CMA): The appraiser compares the home to similar ones in the neighborhood (called “comps”) to estimate its value.
- Market conditions: Trends in neighborhood property values, days on the market, and oversupply or shortage of comparable properties will also be considered.
Your lender will get a copy of the report and share it with you, and the seller can request a copy from the lender. The appraisal fee is part of the buyer’s closing costs.
What Happens When an Appraisal Comes in Low?
Lenders won’t approve a loan for more than the appraised value because they won’t loan more than the home is worth. Getting a low appraisal can put both the buyer and seller in a tough position. In a seller’s market, the buyer may end up paying more than they wanted to, and in a buyer’s market, the seller may have to settle for less. Depending on the amount of the appraisal gap — the difference between the appraised price and the purchase price — you may have to walk away from the deal entirely.
5 Options for the Buyer When an Appraisal Is Low
- Pay the difference: If you have the extra cash, you can increase your down payment so that the loan amount matches the appraised value.
- Negotiate with the seller: You and your real estate agent can explain the situation to the seller and ask them to lower the price. “If there are multiple offers and buyers are willing to go far over the listing price, normally the seller’s willing to bring a certain amount of cash to the table in case of a low appraisal,” says Ruthann Hewgley, a real estate agent with Realty Pro Oregon in Portland, Oregon.
- Challenge the appraisal: You and your real estate agent can submit a reconsideration of value (ROV), in which you research comparable homes and submit evidence that the house should be appraised at a higher value. “It’s not an easy process, but I’ve had it work before,” Hewgley says.
- Get a second appraisal: You can request a second appraisal, at an additional cost, from your lender or change lenders if you think it might result in a more favorable outcome.
- Walk away: If your purchase agreement includes an appraisal contingency, you can back out of the sale and get back all or part of your earnest money deposit, depending on contract terms. If you walk away without an appraisal contingency, you will lose your deposit, and the seller might seek legal action.
5 Seller Strategies to Address a Low Appraisal
- Pay the difference: You can offer to pay the appraisal gap on behalf of the buyer.
- Split the gap: You can propose splitting the cost of the appraisal gap with the buyer, each paying half.
- Accept a lower sale price: While dropping the sale price will ultimately cost you money, it will save you from finding another buyer and possibly encountering the same appraisal issue.
- Renegotiate the purchase agreement’s terms: While you might be stuck lowering the sale price, you can use the opportunity to try and negotiate new terms with the buyer.
- Relist the property: If the buyer walks away, you can make property improvements you may have skipped to increase your home’s value and sales price.
What Does a Low Appraisal Mean for Your Mortgage Loan?
Depending on your loan, your lender might look for a certain loan-to-value (LTV) ratio, which is the difference between a home’s appraised value and the loan amount. Lenders frequently use a property’s LTV ratio to evaluate risk when they issue a loan.
When an appraisal is lower than your offer price, this can raise the loan-to-value ratio, and some lenders may decide that the loan is too risky to approve. If you’re not denied the loan, the lender may require a higher down payment, at perhaps a higher interest rate, and you could be required to purchase private mortgage insurance (PMI), resulting in a higher monthly mortgage payment.
How you deal with a low appraisal depends on what type of loan you’re seeking:
- Conventional loans: Appraisal contingencies are optional in some states, so you may want to add one to the purchase agreement for extra protection. The seller can contribute a certain percentage of the contract price to help offset the appraisal gap in the down payment.
- Government-backed loans: FHA loans and VA loans must include an appraisal contingency, so you can easily walk away if the appraisal is low. These often have stricter appraisal requirements, so you might choose to switch to a conventional loan to seek a second appraisal. The seller can’t contribute directly to the down payment to help make up the difference, but they can help with closing costs up to a certain percentage of the purchase price.
Can a Low Appraisal Be a Good Thing?
Yes, but only for you as the buyer. If you can renegotiate the sale price with the seller, you can get the house for less, and a low appraisal could mean lower property taxes. However, the seller sees little benefit from a low appraisal.
Is a Low Appraisal a Deal-breaker?
Not necessarily. If you can make up the difference in cash or renegotiate the purchase price with the seller, you can still buy the home. But if you’re short on cash or can’t come to an agreement with the seller, you may have to walk away. An experienced real estate agent can help you navigate the process.
Source: homes.com