How to Bridge the Appraisal Gap in Today's Real Estate Market
If you’re searching for drama, don’t limit yourself to Netflix. Instead, tune in to the real estate market, where the competition among buyers has never been fiercer. And with homes selling for record highs,(1) the appraisal process—historically a standard part of a home purchase—is receiving more attention than ever.
That’s because some sellers are finding out the hard way that a strong offer can fizzle quickly when an appraisal comes in below the contract price. Traditionally, the sale of a home is contingent on a satisfactory valuation. But in a rapidly appreciating market, it can be difficult for appraisals to keep pace with rising prices.
Thus, many sellers in today’s market favor buyers who are willing to guarantee their full offer price—even if the property appraises for less. For the buyer, that could require a financial leap of faith that the home is a solid investment. It also means they may need to come up with additional cash at closing to cover the gap.
Whether you’re a buyer or a seller, it’s never been more important to understand the appraisal process and how it can be impacted by a quickly appreciating and highly competitive housing market. It’s also crucial to work with a skilled real estate agent who can guide you to a successful closing without overpaying (if you’re a buyer) or overcompensating (if you’re a seller). Find out how appraisals work—and in some cases, don’t work—in today’s unique real estate environment.
An appraisal is an objective assessment of a property’s market value performed by an independent authorized appraiser. Mortgage lenders require an appraisal to lower their risk of loss in the event a buyer defaults on their loan. It provides assurance that the home’s value meets or exceeds the amount being lent for its purchase.
In most cases, a licensed appraiser will analyze the property’s condition and review the value of comparable properties that have recently sold. Mortgage borrowers are usually expected to pay the cost of an appraisal. These fees are often due upfront and non-refundable.(2)
Appraisal requirements can vary by lender and loan type, and in today’s market in-person appraisal waivers have become much more common. If you’re applying for a mortgage, be sure to ask your lender about their specific terms.
If you’re a cash buyer, you may choose—but are not obligated—to order an appraisal.
APPRAISALS IN A RAPIDLY SHIFTING MARKET
An appraisal contingency is a standard inclusion in a home purchase offer in many states, but NOT in North Carolina. North Carolina is somewhat unique in that the Due Diligence Period provides time for the buyer to do all of their examinations of a home, including getting an appraisal and loan approval with no obligation to the seller to release the buyer from the contract. Basically, this means there are no “contingencies” in the standard North Carolina home contract. At the same time, the buyer can terminate the contract if the appraisal is not what is expected and the buyer and seller can’t reach agreement.
Low appraisals are not common, but they are more likely to happen in a rapidly appreciating market, like the one we’re experiencing now.(3) That’s because appraisers must use comparable sales (commonly referred to as comps) to determine a property’s value. These could include homes that went under contract weeks or even months ago. With home prices rising so quickly,(4) today’s comps may be lagging behind the market’s current reality. Thus, the appraiser could be basing their assessment on stale data, resulting in a low valuation.
HOW ARE BUYERS AND SELLERS IMPACTED BY A LOW APPRAISAL?
When a property appraises for less than the contract price, you end up with an appraisal gap. In a more balanced market, that could be cause for a renegotiation. In today’s market, however, sellers often hold the upper hand.
That’s why some buyers are using the potential for an appraisal gap as a way to strengthen their bids. They’re proposing to take on some or all of the risk of a low appraisal by adding a gap coverage clause to their offer.
Appraisal Gap Coverage Buyers with some extra cash on hand may opt to add an appraisal gap coverage clause to their offer. It provides an added level of reassurance to the sellers that, in the event of a low appraisal, the buyer is willing and able to cover the gap up to a certain amount.(5)
For example, let’s say a home is listed for $200,000 and the buyers offer $220,000 with $10,000 in appraisal gap coverage. Now, let’s say the property appraises for $205,000. The new purchase price would be $215,000. The buyers would be responsible for paying $10,000 of that in cash directly to the seller because, in most cases, mortgage companies won’t include appraisal gap coverage in a home loan.(5)
Waiving The Appraisal Contingency
Some buyers with a higher risk tolerance—and the financial means—may be willing to cover any appraisal gap altogether. However, this strategy isn’t for everyone and must be considered on a case-by-case basis.
It’s important to remember that any appraisal clause added to the offer can leave a buyer vulnerable if the appraisal comes back much lower than the contract price. Without an appraisal clause, a buyer will be obligated to cover the difference or be forced to walk away from the transaction and relinquish their due diligence fee to the sellers.(6)
It’s vital that both buyers and sellers understand the benefits and risks involved with these and other competitive tactics that are becoming more commonplace in today’s market. It’s also important to understand the nuances of North Carolina’s laws and contracts in this regard. I can help you chart the best course of action given your individual circumstances.
DON’T WAIVE YOUR RIGHT TO THE BEST REPRESENTATION
There’s never been a market quite like this one before. That’s why you need a master negotiator on your side who has the skills, instincts, and experience to get the deal done...no matter what surprises may pop up along the way. If you’re a buyer, I can help you compete in this unprecedented market—without getting steamrolled. And if you’re a seller, I know how to get top dollar for your home while minimizing hassle and stress. Contact us today to schedule a complimentary consultation.
Sources (Please note, some of what is presented in these articles may not apply in North Carolina):
2. US News & World Report - https://realestate.usnews.com/real-estate/articles/what-is-a-home-appraisal-and-who-pays-for-it
4. S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index - https://www.spglobal.com/spdji/en/indices/indicators/sp-corelogic-case-shiller-20-city-composite-home-price-nsa-index/#overview
5. Bigger Pockets - https://www.biggerpockets.com/blog/appraisal-gap-coverage