You’ve found it: your dream home. And it’s dreamy enough that you’ve put in an offer. But then the appraiser comes back with its report — and the figure is substantially lower than the agreed-upon sales price. This difference is what’s known as an appraisal gap.
An appraisal gap can certainly be a major inconvenience in the homebuying process — but fortunately, there are options, including renegotiating with the seller or walking away from the sale entirely. Below, we’ll outline everything you need to know about appraisal gaps, including ways to deal with them.
Why Would an Appraisal Gap Occur?
An appraisal gap happens when the appraised value of the home you intend to buy is lower than the agreed-upon purchase price.
It’s possible that you’re in a hot real estate market, and buyers competing for homes are engaging in bidding wars that push up home prices beyond their material value. Even if you weren’t engaged in a bidding war yourself, the seller’s price might reflect a rapid rise in local market prices.
Or maybe the seller simply overestimated when setting their asking price. While a seller’s market increases the chances of an appraisal gap, sometimes they just happen — no matter what’s going on in the real estate market in your area. The property valuation the seller used to price the house may simply be different from the appraiser’s estimate.
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Impact of Appraisal Gaps
Obviously, spending more on a home than it’s worth has a variety of consequences, both on the buyer’s finances and on the home purchase process itself. Here’s a closer look.
Effects on Home Purchase
If you’re like most Americans — and especially first-time homebuyers — chances are you’re planning to use a mortgage loan to purchase your home. But lenders don’t typically approve mortgages for more than the home’s fair market value. (In fact, it was probably your lender that required the home appraisal that showed the appraisal gap in the first place, for precisely this reason.)
Obviously, this means an appraisal gap could cause trouble for those trying to qualify for a mortgage by lowering the amount the bank is willing to lend and increasing the amount of cash the buyer needs on hand to successfully make the purchase.
Even if you could successfully take out a loan for more than the home’s appraised value, you’d be starting your purchase with negative equity, which would substantially lengthen the time frame it would take to start building wealth in your home.
Financial Implications
Along with hitches in the homebuying process, an appraisal gap could have substantial financial implications, too. For example, you may need to dig up additional cash in order to cover the gap — or crack your knuckles and head back to the table to renegotiate with the seller.
In some circumstances, an appraisal gap might even cause you to walk away from the deal entirely — potentially leaving your earnest money (typically 1% to 2% of the purchase price) on the table. The specifics depend on the wording in your purchase contract, which we’ll come back to in just a minute.
What to Do if an Appraisal Gap Occurs
If you’re facing an appraisal gap, there are a few different ways to resolve it.
Renegotiate with the Seller
So long as you’re not contractually bound to cover an appraisal gap by an appraisal gap coverage clause in your contract, you may be able to renegotiate a new purchase price with the seller — one that lines up better with the home’s appraised value.
Cover the Gap Yourself
Perhaps the most straightforward way to resolve an appraisal gap is to simply pony up. Of course, this “simple” fix isn’t necessarily easy for every buyer, given that appraisal gaps can be on the order of tens of thousands of dollars — on top of all the other expenses that come up at the closing table. If you take this route, you might start by asking the seller to meet you in the middle, with each of you covering half the amount.
Dispute the Appraisal
It may be a hassle — and it may not result in any changes — but you could also ask your lender for a review of the appraisal to ensure the value was correctly calculated. You can make a reconsideration of value (ROV) request with your lender. An ROV lets you explain more about why you think the home is worth more than the original appraisal states, including any additional or updated information. You might even get a new appraisal done if your lender will allow it, but it would likely be an additional expense out of your pocket. If you had an appraisal waiver the first time (in which an automated tool is used to estimate the home’s value) you might request an in-person appraisal. But be warned that a second appraisal could return a home value that is higher or lower than your first appraisal.
Cancel the Contract
Finally, of course, if the appraisal gap is simply too much to bear, you can always walk away. Be forewarned, however: If you cancel without an appraisal gap contingency in your contract, you may lose the earnest money you’ve put on the table.
Preventing Appraisal Gaps
Which of the above options are available to you will depend, again, on your purchase contract, which may have an appraisal gap contingency or appraisal gap coverage clause written into it.
• An appraisal gap contingency is a section of the purchase agreement that gives the buyer the right to walk away from the deal if an appraisal gap occurs, without losing the earnest money.
• An appraisal gap coverage clause, on the other hand, states that the buyer is responsible for covering an appraisal gap. But it can also be used to cap how much of an appraisal gap you’re willing to cover as the buyer. For instance, it may say that you agree to cover an appraisal gap of up to $20,000 — but if the difference climbs beyond that, you have the right to walk away without financial penalty.
Writing in an appraisal gap coverage clause can be a useful tool in a seller’s market, when you’re bidding against other would-be purchasers. It can help ensure you don’t spend more than you can afford. On the other hand, if you’re unwilling to foot the bill of any appraisal gap whatsoever — even if it makes you a slightly less competitive buyer — consider adding an appraisal gap contingency to your contract.
The Takeaway
An appraisal gap — the difference between the appraised value of the home you’d like to buy and the agreed-upon purchase price — can be a fly in the home-purchase ointment. But not everything is lost, particularly if you have your purchase contract written in a way that circumvents the problem in the first place. If necessary, prepare to negotiate and possibly spend more out of pocket to complete your home purchase.
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FAQ
Who is responsible for covering an appraisal gap?
It depends. If there’s an appraisal gap coverage clause in the purchase contract, the buyer is likely responsible for covering an appraisal gap — though only up to specified limits. (Appraisal gap coverage clauses are common in competitive markets, where sellers have more leverage.) However, if your contract includes an appraisal gap contingency, you may be able to take the seller back to the table and renegotiate a lower purchase price — or walk away from the sale entirely.
Can a low appraisal be challenged or appealed?
Yes. If you think the home has been valued at a lower price than is accurate, you can put in what’s called a reconsideration of value (ROV) request with your lender. An ROV gives you the opportunity to explain more about why you think the home is worth more than the original appraisal states, including any additional or updated information. However, it’s no guarantee that the appraisal gap will close 100% — or at all.
How common are appraisal gaps in the home-buying process?
Appraisal gaps don’t happen in the majority of sales — but they’re not uncommon, either. It’s somewhat more likely that an appraisal gap will happen in a hot real estate market, when multiple bids from prospective buyers could push the purchase price up beyond the home’s fair market value.
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