As house prices have risen at an alarming rate, an increasingly prevalent problem for real estate residential property traders has emerged: the appraisal gap.
When a house’s assessed value is less than the agreed-upon purchase price, purchasers have three options: pay the difference, bargain, or withdraw from the acquisition agreement.
Fortunately, there are many options for dealing with an appraisal gap. The purchasers of real estate must work very carefully with real estate agents to construct an offer that protects against appraisal gaps and has a plan in place in the event that one happens.
Basics of Real Estate Transaction
If you are a first-time home buyer and unfamiliar with the process of real estate, you may find the paperwork overwhelming. For starters, you may have to secure the services of a real estate agent as well as a loan officer.
One of the processes in purchasing a home is the home appraisal. If you decide to purchase your new home through cash, there is no need to worry about this step.
However, if you opted to take on a mortgage loan, your creditor will demand an appraisal.
Home appraisals estimate the value of the home you are planning to purchase.
Home appraisals are requisite in the process as it provides protection for the buyer and the creditor. It prevents either party from paying excessively more than the correct amount by using a systematic valuation process conducted by an impartial third party.
In the case of the creditors, home appraisals verify that the sales amount is in alignment with the value of the home depending on its condition, features, and location.
It also assures the creditor that in the event of failure of a mortgage payment that the property can be held for sale.
Who Determines an Appraisal?
A real estate appraisal is a professional assessment of value provided by a licensed appraiser.
Mortgage lenders engage appraisers for a variety of loan products, including refinance, loans on a home purchase, home equity line of credit (HELOC) loans, and many more.
A purchase price is included in each sales contract. Provided the property appraises at its fair market value, the bank decides to grant the buyer money for the purchase of the property.
Because assessments are based on subjective views, there is a margin of inaccuracy. For the same property, you might engage three different appraisers, each of whom would provide three separate estimates of its worth.
How Are Home Appraisals Determined?
An appraisal will be ordered by the mortgage lender after a house has been placed under contract and has finished the home inspection procedure. This is where the appraisal process starts.
The real estate appraiser assigned to the property will then examine the property to conduct a visual check and photograph the property. Following that, they will contrast facilities and attributes to previously sold residences in the same area.
Preparing the appraisal report is the final stage in the house appraisal process. The appraiser’s report is a detailed document that compiles all the information gathered during the appraiser’s tour.
The appraiser sends the report to the lender, along with an assessment of the home’s fair market value. The document also goes into detail about the factors and facts that led to the final decision.
Home Appraisal Time Frame
Depending on the appraiser’s workload and the complexity of the report, this process can take anywhere from one to two weeks.
Situation under Hyperinflation
The appraisers in overinflated real estate markets have a difficult task in attempting to describe some of the outlandish sales contracts presented by listing agents.
Their responsibility is to prevent the financial institution from over-lending while also safeguarding customers from having their transactions fall apart.
Appraisal Gap: An Overview
An appraisal provides financial coverage for the buyer if in case there is a significant disparity between the purchase agreement and the actual market value of the home. That’s where appraisal gaps come into the picture.
Now, what is an appraisal gap?
The appraisal gap is described as a difference in the agreed payment amount and the estimated value of the property according to the real estate appraiser.
You may want to seek appraisal gap examples to complement your understanding concerning the appraisal gap.
Appraisal Gap Coverage Explained
In a seller’s market, especially a hot market, when bidding wars on properties are commonplace, valuation disparities are typical.
As there are more people looking to purchase a house than there are homes available on the market, there is significant upward pressure on property listing prices.
When the price of a property goes up more quickly than previous sales of properties that are comparable to it, it becomes difficult for an appraised value to stay up.
In addition, valuation discrepancies become more prevalent when buyers offer more than the property’s proposed price in an effort to acquire it.
Due to the greater likelihood that a property may not appraise, home sellers often seek extra cash offers to avoid this problem. A buyer might alleviate a seller of this concern by agreeing to cover the appraisal gap in an assessment.
As part of their offer, the buyer stipulates in writing that they would pay any difference in the home’s appraised value. It is known in the real estate industry as the appraisal gap guarantee, appraisal gap clause, or appraisal gap coverage clause.
Appraisal Gap Clause Explained
Found in a purchase contract, the appraisal gap clause is also referred to as the appraisal gap guarantee or appraisal gap guarantee clause, or appraisal gap coverage clause.
It is a clause stating that the buyer is exclusively responsible for the differing amount between the home’s assessed worth and the contract price, with a maximum sum specified.
During bidding wars, the appraisal gap clause might strengthen your offering. It gives further security to the seller that the deal will not collapse owing to a bad assessment.
It is possible that the buyer will not have to try to haggle the purchase price and otherwise risk losing the item to another bidder if they do not have to.
In some circumstances, appraisers struggle to find the actual market value of a property. The sales data do not always justify the high contract pricing.
This is when the appraisal gap clause in a purchase contract is advantageous. It may limit or eliminate the possibility of the seller incurring losses due to a poor evaluation.
Appraisal Contingency Clause Explained
The majority of real estate sales contracts will include a contingency clause. This provision permits the home buyers and buyer’s lender to exit the sales contract if an appraised value of the property falls below the purchase price.
A contingency clause specifies an action, circumstance, or event necessary for a real estate contract to become enforceable.
When both the buyer and the seller agree to the conditions and sign the sales contract, the condition becomes part of a legally enforceable sales agreement.
Consequently, it is essential to know what you are entering into if a contingency clause is shown in your real estate agreement.
It will protect the buyer by ensuring that the property is appraised at a minimum market value. In many instances, the earnest money is returned to the buyer if the property appraises for less than the minimum price set in the contract.
Appraisal Gap Coverage vs Contingency
The distinction between appraisal contingency and appraisal gap should be established. A provision including an appraisal contingency allows the buyer to terminate the contract if the contract price does not match the assessed value.
With no contingency on the appraisal, you might possibly lose your escrow-held earnest money deposit. Typically, it ranges between one and 5% of the purchase price.
Relying on which side of the fence you sit as a real estate agent might determine the shape of the sales contract. Functioning in a competitive market may also determine the language of the real estate contract.
Limiting the Appraisal Gap Coverage
In a seller’s market, it is significantly more difficult to win the offer. There is often intense rivalry among the majority of residents. You would like to create a competitive offer, but you do not want to overpay much for a house.
Keep in mind that by reducing the appraisal gap coverage, the seller and listing agent will view your offer less favorably. With little inventory and strong demand, it may be essential to entirely fill the appraisal gap.
Example of Limiting Appraisal Gap Coverage Clause
If this is your circumstance, you may submit an offer with restricted appraisal gap coverage. For instance, a home’s asking price is $800,000. You may submit a $700,000 offer but then only agree to pay a $50,000 assessment shortfall.
Therefore, if the evaluation is at least $850,000, there will be no appraisal gap. If the determined appraised value was less than $850,000, you might possibly withdraw from the transaction.
Handling Appraisal Gap
The buyer carries a significant role in dealing with the appraisal gap as part of the process of purchasing a house. Guiding you through, here are five ways to work effectively and wisely with the appraisal gap.
Reduce the Percentage of Down Payment
The buyer has the option of decreasing their down payment percentage and using the additional funds to offset the appraisal gap. In fact, this is observed to be the most common way of dealing with the appraisal gap.
The disadvantage of this technique is that if you cut your down payment to a certain percentage, you may be required to pay mortgage insurance, minimum for a temporary period of time.
Cover the Appraisal Gap by Paying in Full
Irrespective of the appraisal value, the buyer is responsible for the gap amount. However, if the appraisal gap is significantly high, there is a chance that the buyer will not be able to pay in full amount, particularly all at once.
If you have the means to do this, you may do it so you will not have to worry in the future about pending payables.
Retry to Negotiate Conditions With The Seller
Once an appraised value was already determined, the buyer and seller may, in all practical senses, restart the negotiation process.
In a market that favors purchasers, the seller can be willing to reduce the price in order to make it comparable to the property’s assessed worth.
The homeowner, on the other hand, is more inclined to go with home buyers who have extra cash and can pay the difference from their own resources when the market is favorable to sellers.
Provide the Appraisal Gap Clause
As said earlier, this provision in a purchase agreement has the potential to save both the buyers and the sellers the time-consuming task of renegotiating the terms of the sale in the event that the appraisal ends up being much lower than expected.
Bring The Contract to an End
Provided you remain covered in the period of the appraisal contingency, you are free to terminate the deal.
If you are unable to reduce the appraisal gap using any of the methods described before this one, you may be left with no other option than to resort to this one, despite the fact that it is typically the least preferred decision.
The Bottom Line
As time passes, appraisal gaps tend to increase throughout the year.
Rising property prices seem like excellent news to sellers. Unless the buyer can afford the differential amount in the event of a low appraisal, this is not the case.
If you are unsure about the transaction you are about to make, you can always work with a real estate professional to help you arrive at the most reasonable potential outcome. Visit Homes by Ardor to help you in this real estate process.
With the help of one another, everyone needs to stay informed on the most delinquent trends when dealing with real estate transactions.
Kris Reid is the CEO of Ardor SEO, a company that helps real estate professionals get more leads and customers to predictably grow their business.
Over the years, Kris acquired extensive knowledge of SEO and its practical applications in various industries, with the main focus on real estate.
In 2021 Ardor launched the Icons of Real Estate Podcast to share proven strategies from the top producing icon agents with the real estate community.
After obtaining the real estate license in 2022, Kris joined eXp Realty and launched Homes by Ardor, the platform that was built to be the fastest way to buy or sell a house. Homes by Ardor also provides leads for its partner companies and realtors.