If you have an appraisal gap when the home you buy is valued, there is a difference between the amount you have offered for the home and the value determined by the appraiser.
An appraisal gap is not unusual when prices rise faster than comparable sales.
When buying a home, this can be a severe issue that could lead to the purchase falling apart, but an appraisal gap clause could be the answer.
What is an appraisal?
An appraiser is hired by a lender to independently confirm the home’s value. This is used when someone needs a mortgage, is looking to refinance, or takes out some other type of loan on the home.
When the buyer offers a price for the home, their lender will help fund the purchase as long as the property appraises. The appraisal protects the lender, ensuring the home is worth the amount they lend to the buyer.
However, an appraisal is just the appraiser’s opinion, and another appraiser could come up with a different valuation. In many real estate contracts, an appraisal contingency will allow the buyer to escape the sale when the appraisal is low.
Appraisal contingencies are more common in buyer’s markets and much less so in seller’s markets.
How an appraiser finds the value
An appraiser is trained and licensed to find the current market value of a home. The appraiser will use recently sold prices in the same area, often called comps, to find the valuation. They will compare the features of these comparable homes to estimate the value of the property in question.
A real estate appraiser will be hired when the buyer’s offer has been accepted and the home inspection completed. The appraiser will create a report based on their findings when they visit the property, taking photos and measurements. These details will be compared to the other homes sold recently in the neighborhood.
It can be difficult for the appraiser if there haven’t been many properties sold in the area, and a fast-moving property market is also a problem. With prices rising fast, comparable homes might not reflect the current market conditions. The appraiser wants to ensure that the lender doesn’t provide more money than could be recovered should the home foreclose. But they also need to represent the current value of the home fairly.
In these situations, there is more chance of a difference between the purchase price and the appraised value.
What is an appraisal gap clause?
An appraisal gap clause is often used in a seller’s market for a buyer to make their offer more attractive.
If the appraiser’s valuation does not meet the agreed purchase price of the home, the buyer may have to find the difference by increasing their down payment. One of a seller’s fears in an escalating market is that their home will not appraise.
The appraisal gap guarantee clause relieves this fear because the buyer will put up any money needed to satisfy the lender.
How an appraisal gap guarantee works
If there is an appraisal gap, something must be done to keep the purchase alive. The appraisal gap clause can state the buyer will commit to paying the difference in the appraised value and the contract price.
This could mean the buyer agreeing to spend a certain amount to close the gap and continue the purchase.
If the buyer purchases a home in a seller’s market, this guarantee will make their offer more attractive. Bidding wars and escalation clauses are more likely, pushing up prices as buyers compete with each another. With prices rising quickly in a seller’s market, there is a greater chance of a gap when the home is appraised.
The guarantee will make the seller less at risk of losing money should there be an appraisal gap. Without this guarantee, the seller might drop their price or relist the home to find a buyer.
An appraisal gap clause is the exact opposite of an appraisal contingency clause.
How to include appraisal gap coverage in a purchase contract
Your real estate agent can include appraisal gap coverage in the contract. This clause needs to state the maximum amount of money the buyer will spend to cover the gap.
While offering to cover any gap might be tempting, as you might not expect it to be too large, this could be a mistake. If the appraisal comes in lower than hoped, you will need to cover the gap, or you will breach the contract.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 35 years. Bill is the owner and founder of Maximum Real Estate Exposure. For the past decade, he has been one of the top RE/MAX REALTORS® in New England.