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What Home Buyers Need To Know About Appraisal Gaps

Victoria Araj6-minute read

November 21, 2022

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Buying a home is exciting, but when there’s a gap between the appraised value and your agreed-upon sales price, problems may result. You risk losing the home you’re interested in and possibly even your earnest money.

For everything you need to know about appraisal gaps and how to handle them, check out our complete guide below.

What Is An Appraisal Gap?

An appraisal gap is the difference between the fair market value determined by an appraiser and the amount you agreed to pay for the home. An appraisal gap doesn’t mean you have to cancel the sale, but it may mean you have to negotiate with the seller or pay the difference for the home out of pocket.

What’s The Appraisal Guarantee Clause?

Some sellers require what’s known as an appraisal guarantee clause. This is common in a seller’s market where buyers outnumber sellers and sellers can call the shots. The appraisal guarantee clause states that the buyer will make up the difference if the appraisal is lower than the accepted offer.

This isn’t your only option, though, as we’ll discuss later.

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How The Home Appraisal Process Works

A home appraisal is an evaluation and report that a licensed appraiser performs to determine a home’s fair market value. Lenders usually require a home appraisal to ensure the amount you agreed to pay for the home is equal to or less than the appraised value.

A home appraisal is important for you and the lender. Most home buyers don’t want to invest more in a home than it’s worth. You’d have negative equity right away, and it would take much longer to establish positive equity. Lenders use appraisals to ensure the collateral (the home) is worth enough if the borrower defaults on the loan.

In a seller’s market, many prospective buyers will get into bidding wars and possibly waive the appraisal contingency or offer an appraisal guarantee up to a certain amount. In both cases, the buyer would have to come up with the difference in cash between the appraisal value and the purchase price, or their appraisal guarantee and the sale price.

Appraisers evaluate a home based on these factors:

  • The home’s condition: An appraiser carefully examines a home’s safety, sanitation and soundness. They’ll count the number of bedrooms and bathrooms, make sure the home is livable, confirm that all systems are functioning, and verify that there aren’t any major issues with the home.
  • Comparable sales: An appraiser compares the home to similar homes in the area (“comps”) that sold within the last 6 months (sometimes shorter, sometimes longer). They’ll look for homes with similar structures and features to determine the subject property’s fair market value. This also gives buyers a chance to see how close the asking price is to the fair market value.

The appraiser’s evaluation is important because the difference between your home’s appraisal amount versus loan amount can determine how much money you’re allowed to borrow. For starters, lenders won’t approve a loan for an amount higher than the home’s value. If, for example, you bid $200,000 on a home, but it’s worth $190,000, lenders will base your loan amount off the $190,000 value.

What Should You Do When The Appraisal Is Less Than The Offer?

You have several options – including walking away from the sale – when the appraisal is less than the offer. Walking away doesn’t work in every situation, however. Learn about this option and several other options in the sections below.

Pay The Difference

If the seller won’t negotiate the price lower, you’ll be on the hook to pay the difference unless you have an appraisal contingency in your contract. The appraisal contingency gives you a way out of the contract without losing your earnest money. In the absence of an appraisal contingency, you must buy the home or risk losing your earnest money.

Without a lower sales price, you’ll have to pay more for the home. Since lenders base your loan amount on the appraised value, you’ll need your agreed-upon down payment plus the difference between the sales price and appraised value.

What if you don’t have the cash? Ask for gift letters from family members or leverage your investments. You may be able to use some retirement funds without paying a penalty. Talk with your 401(k) administrator or tax adviser to see your options. If you own other real estate, consider tapping into the equity and using the funds to cover the appraisal gap.

Renegotiate The Offer

If you have an appraisal contingency on your sales contract, you may be able to work with the seller. Start by requesting the seller to lower the price to the appraised value. This would eliminate the appraisal gap and your roadblock to buying the home.

If the seller is unwilling to lower the price to meet the appraised value, ask them to split the difference. For example, if there’s a $10,000 difference, ask the seller to lower the price $5,000 while you contribute the other $5,000.

Asking the seller to renegotiate can be risky in a seller’s market, so it’s best to tread cautiously. If the seller has a kick-out clause, they could accept another offer that comes through. They still must give you the time to remove your appraisal contingency and seal the deal, but they can choose the other offer if you don’t.

Dispute The Appraisal

Sometimes, buyers (or sellers) don’t agree with the appraisal. In this case, you can dispute the appraisal, asking for a reconsideration of value. However, this isn’t easy to do. You’ll need plenty of evidence to prove the appraisal is inaccurate.

You must prove one of the following:

  • The appraiser didn’t use appropriate comparable sales, and more accurate options are available
  • The appraiser missed features or upgrades in the subject property
  • You found mistakes in the report
  • The appraiser only conducted a drive-by or exterior appraisal

To dispute the appraisal, you must do so in writing. Carefully craft a detailed letter stating why you’re disputing the appraisal and showing your proof to back up your claim. Keep your letter short, polite and to the point, and supplement it with as much evidence or research as possible.

Walk Away from the Sale

It’s not the ideal choice, but if you’re worried about paying more than a property is worth, walking away from the sale can be the best option. If you’ve unsuccessfully renegotiated with the seller and disputed the appraisal to no avail, it may be best to look for another property.

Before doing this, talk with your attorney. If you didn’t include an appraisal contingency in your contract, you might risk your earnest money. Other contingencies, such as a mortgage financing contingency, may still help, though.

Homeowners considering a refinance should also know that a low appraisal is possible, You can dispute it on the same grounds you would a purchase with good reason.

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Appraisal Gap Coverage Vs. Appraisal Contingency

When you’re buying a home, you’ll likely hear two words thrown around before you sign the contract – appraisal gap coverage and appraisal contingency.

They sound similar but have different meanings.

Appraisal gap coverage isn’t an insurance policy, even though it sounds like one. Instead, it’s wording in the contract that binds you to buy the home even if the appraisal comes in lower. Pay attention to this area of the contract and either ask for it to be removed or put a cap on how much you’re willing to pay to cover an appraisal gap.

An appraisal contingency gives you a legal way out of the contract if the appraised value doesn’t match your agreed-upon sales price. The contingency allows you to back out of the contract and keep your earnest money. If you opted out of the contract without the contingency, the seller could keep your earnest money, which is often 1% – 3% of the sales price.

When Is An Appraisal Gap Coverage Clause Necessary?

While no one wants to pay more than a home is worth, it may be necessary in a competitive seller’s market. If you want your bid to outshine the others, an appraisal gap coverage clause may be worth including. The appraisal gap clause states how much of an appraisal gap you’re willing to cover. Since there’s no guarantee an appraisal will match the agreed-upon sales price, sellers often want to be assured the offer will still stand even if the appraisal comes in a little low.

In the appraisal gap coverage clause, you and the seller must agree on how much you’re willing to pay above the appraised value and if you want to split the difference. Agree on as much as possible, putting it in writing before signing the contract. This will likely alleviate some stress and help you avoid unnecessary renegotiations after the appraisal.

The Bottom Line

It’s never pleasant to learn about an appraisal gap after you’ve signed a sales contract, but it’s often a reality in a fast-paced real estate market. It’s essential to protect yourself going into the contract, which means devising a plan on how to proceed if the appraisal comes in lower than expected. Buyers have many options, but you should always choose the one that’s most comfortable for you.

Beginning the home buying process or considering a refinance? Get the approval process started today with Rocket Mortgage®. You can also give us a call at (833) 326-6018.

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Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.