You may be hearing a lot lately about appraisals, low appraisals, appraisal gaps, etc. Let’s first start off by making sure we understand what exactly an appraisal is, and the purpose that it serves.
An appraisal is a professional valuation of a property done by an appraiser, who is a third party to a Real Estate transaction, and who has no stake in the game. An appraisal is ordered and required by the Lender in the majority of financed purchases. The appraisal ensures that the offer the Buyer made, and the agreed upon contractual purchase price, is indeed market value for the property. This provides assurance for the lender, that if they need to ever foreclose on the property, that they have not lent more to the Buyer than what the property is worth, since the bank will then have to sell the property.
The recent market has been an extremely hot Seller’s market. There have been significantly more Buyer’s wanting to buy than there have been properties available to buy. This has created bidding wars, resulting in Sellers receiving multiple offers, and offers way over the asking price.
In these scenarios, while what a Buyer is offering to pay is the Buyer’s perceived value of the house, the recent comparable sales of similar properties may not support this value. In these cases, it is likely that the appraisal will come in lower than the contract purchase price, and therefor the lender will not pay as much as the Buyer would need.
So how do you resolve this dilemma? There are essentially three options:
- If you have an ‘appraisal contingency’ (standard in the California Real Estate Purchase Agreement template), this scenario will allow you to cancel the contract.
- Try to re-negotiate the purchase price with the Seller to be the appraised value.
- Offer to pay the ‘appraisal gap’, AKA the difference between the contract price and the appraised value.
Because of the bidding wars that we have been seeing recently, we have also been seeing a lot of Buyers offering to ‘waive’ the appraisal contingency. This is stating that if the appraisal comes in low, they agree to pay the difference. This can be a good strategy to help make your offer stronger, but also comes with some risk that Buyers should fully understand.
First thing to note is that if you as a Buyer are approved up to a certain amount, that does not mean that the lender will lend that to you regardless. If you are purchasing a property less than your approval amount, the Lender will still only lend based upon the property’s value.
Secondly, if there is any concern of an appraisal gap, you should have a good understanding of what the appraised value should be. Ask your Realtor to provide ‘comps’, or comparable sales, to get an idea of what the Appraiser will reference when creating the appraisal. This should give a good idea of how much a potential gap would be, and then you can strategize accordingly.
Lastly, if you do agree to cover a potential appraisal gap, along with previous point, make sure you have a clear gauge of how much cash you would feel comfortable paying. If your gap could be $20k, and you only feel comfortable paying an additional $10k, instead of offering to waive the appraisal contingency completely, you can offer to cover any appraisal gap ‘up to $10k’.
While there are other ‘outs’ in most contracts if need be, its important to have a clear understanding of what you are offering and agreeing to. If you agree to something that you cannot adhere to, that could potentially open yourself up to court action or being sued for damages. Make sure to have a good Realtor who is looking to protect you, and making sure you are not opening yourself up to situations that could put you at risk. Comment and reach out for any additional information!