When you’re buying or selling a home, hearing the words “appraisal gap” can make you shudder. An appraisal gap can make the difference between a successful sale or the deal falling through completely. But how does an appraisal gap happen and what can you do to avoid it as a buyer or seller?
When you put your home on the market, you list it at a certain price. Let’s say you put it on the market for $350,000. Then, when a buyer wants to purchase the home, they’ll make an offer—let’s say they offer $360,000. If they’re financing, their lender will order an appraisal of the home during the closing period.
An appraiser will come look at the home and determine its fair market value. An appraisal gap occurs when the home’s appraised value is lower than the buyer’s offer.
In this example, let’s say that the home’s appraised value is $340,000, $10,000 less than the buyer’s offer. Lenders don’t really like this. Why? Well, if you were to default on your mortgage and be unable to pay the bank back, they wouldn’t be able to recoup their investment. Because of this, banks typically won’t give you more money than what the home is worth. Often, this gap causes the offer to fall through.
But there are some things you can do in this situation as a buyer. First, you can write an appraisal gap guarantee clause into the purchase contract that says you’ll pay a predetermined amount above the appraised value. You also have the option to pay the gap in cash. In our case, you’d have to pony up $10,000 to give to the seller. You could also renegotiate with the seller on price and try to get the purchase price closer to the appraised value. And as a last resort, you can walk away if you have an appraisal contingency in the contract.
You’ll obviously want to avoid this as a seller, too. It’s good to keep in mind that only buyers with financing will have this issue with the bank, which means that cash transactions can go more smoothly.
Appraisal gaps can be bad news, but if you’re educated and prepare for them, they aren’t anything to be afraid of.