6 minute read
August 3, 2022

How Does an Appraisal Gap Clause Work?

How Does an Appraisal Gap Clause Work?
6 minute read
·
August 3, 2022

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With the competitive nature of the current seller’s real estate market, many buyers are choosing to make bids above the seller’s asking price. 

However, with appraisal values failing to keep up with surging market prices, buyers can wind up in a situation where the appraised value of the home they want to buy is substantially less than the price they’ve offered. 

This is what’s commonly known as an “appraisal gap.”

Understanding what an appraisal gap is, how appraisers determine a home’s value, and how the appraisal gap clause works can help you make an informed home buying decision.

What is an appraisal gap?

In simplest terms, an appraisal gap is the cost difference between the appraised value of a home, i.e., how much a property is worth, and the purchase price of an accepted offer. 

When a homebuyer agrees to pay a specific amount for a home, and an appraiser values the home for less than the buyer-specified amount, you get an appraisal gap.

With today’s competitive real estate market, it’s common for an appraisal to come in at a value less than what a buyer has offered.

Three things can occur, and are becoming more common when an appraisal gap happens: 

  1. The buyer can agree to make a cash payment at closing to cover the difference 
  2. The seller can agree to reduce the home’s price, to match the appraised value
  3. The deal falls through and the buyer walks away from the house

The appraisal gap must be resolved for the deal to proceed; it can’t move forward. 

Without resolving the appraisal gap, the deal falls apart.

That’s why it’s essential for buyers and sellers to understand their options—before entering into the purchase contract. 

Appraisal gap example

You found a home you want to buy. It’s listed for $150,000, and you offer $155,000.

The seller accepts your offer, and your potential home is appraised as part of your mortgage approval process. 

The independent appraiser determines your new home’s value to be $145,000. 

In this scenario, you have an appraisal gap of $10,000 between the appraised value of the home ($145,000) and your contact price ($155,000).

Step 1 of 7

In what ZIP code are you thinking of buying?

What is an appraisal gap clause, and how does it work?

An appraisal gap clause says the buyer agrees to cover the gap between the home’s appraised value and the contract price. 

The amount of an appraisal gap is not included in the mortgage loan amount; the buyer typically pays the difference, in cash, at closing.

Example of an appraisal gap clause

A buyer offers $100,000 for a home and has an appraisal gap clause in their real estate contract. The seller accepts the offer. 

The home is appraised and the value comes in at $80,000. The deal still moves forward despite the $20,000 appraisal gap. 

In this example, because of the appraisal gap clause, the buyer covered the additional $20,000 of the appraisal gap.

How common are appraisal gaps?

Appraisal gaps are common occurrences in certain situations, including when: 

  • Real estate markets are hot
  • Housing inventory is low 
  • There is a high demand for properties

Any one of these points can result in an increase in appraisal gaps. 

The U.S. housing market has experienced a combination of all three in recent years.

Does a down payment affect the appraisal gap?

Buyers who add appraisal gap clauses to their contract offer agree to pay for the financial difference between appraised value and selling price.

If there’s a gap, the sales price doesn’t change; the buyer simply pays the difference between the two amounts. 

If a buyer has a 100% financing mortgage loan (i.e., USDA home loans or VA loans), the mortgage loan covers 100% of the home’s appraised value, and the buyer pays the appraisal shortage. 

In this situation, buyers will be required to sign an acknowledgment confirming they understand they are paying more than the market value for their home. 

If buyers have a mortgage with a specified down payment amount, such as FHA home loans, the amount of the down payment will be based on the home’s appraised value—not the sales price. 

So while their down payment will technically be less, they will still be required to pay the additional gap between the appraised value and the seller’s price. 

Can you dispute an appraisal gap? 

If your home is appraised for less than the purchase price you offered, you have a few paths forward. Buyers can do the following:

  • Dispute the home’s appraised value/ request a new appraisal
  • Agree to pay the difference
  • Renegotiate the home’s selling price/ ask for a price reduction 

Homes are appraised by independent, third-party contractors who are specialists in determining a home’s value. 

If you feel the appraised value is inaccurate, you can always reach out to the appraiser and verify they used the most current information, i.e., taking any upgrades or improvements into account. 

Additionally, you could ask to have another appraisal done by a different appraiser. 

Buyers may initially want to ask sellers to reduce the price. However, it’s important to realize they may not be successful—especially in a high-demand, the low-inventory housing market or when sellers have received multiple offers. 

If the seller doesn’t agree to a reduced price and you don’t want to pay the gap, you can typically break your purchase under the appraisal contingency clause in most real estate contracts. 

Real estate purchase contracts commonly contain an appraisal contingency clause. 

This clause provides both homebuyers and lenders with an “out” in the event the home appraisal comes in for less than the purchase offer amount. 

The right mortgage for your dream home

If you’re considering buying a home and want to find out how much you could be approved for, reach out to the trusted home loan specialists at Assist Home Loans. 

We’re here to help you choose the right mortgage for your financial situation. 

If you’re ready, start your mortgage application or refinance application online.

Our loan officers can walk you through popular loan programs, including FHA home loans, FHA streamline refinance, VA home loans (including the VA IRRRL), as well as conventional mortgages and refinancing options. 

Contact Assist Home Loans today.

Photo by Jessica Bryant

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