7 minute read
March 29, 2022

How to approach and solve the appraisal gap problem when property values are rising

How to approach and solve the appraisal gap problem when property values are rising
7 minute read
·
March 29, 2022

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What is an appraisal gap?

Appraisal Gap is the difference between the agreed upon purchase price and the appraised value of the property. When values are rising, this becomes a common issue for buyers and sellers because it can affect the ability of the buyer to obtain financing.  A lender will base the loan program’s Loan to Value ratio (LTV) on the lower of the purchase price and appraised value. For those with a lower down payment, this can lead to a situation where the buyer does not have enough closing funds to meet program requirements. For example:

Buyer A is buying a home for $500,000 and using a Fannie Mae HomeReady Mortgage or a Freddie Mac Home Possible Mortgage. Both programs fall into the low down payment home loan category and offer subsidized pricing and mortgage insurance options to first time home buyer’s who meet certain geographical income requirements. The minimum down payment for both programs is 3%, which equals $15,000 on Buyer A’s purchase of $500,000. Let’s assume Buyer A has closing costs of $5,000 total in addition to their 3% down payment. 

The required funds needed to close are equal to the down payment plus closing costs totaling $20,000. Buyer A has exactly $22,000 in verified, sourced and seasoned closing funds.


The appraiser completes the report and issues an opinion of fair market value using the Sales Comparison Approach equal to $480,000. Now the bank will base the allowable loan amount at 97% Maximum Loan to Value Ratio of the appraisal value of $480,000 instead of the purchase price of $500,000. 

The new required down payment and closing cost total is equal to the price minus the maximum loan amount, plus closing costs AND plus the appraisal gap. Here’s how it plays out:

Original Contract Terms

$500,000 Price

$500,000 Appraisal

$485,000 Loan Amount

$15,000 Down (3% of Price)

$5000 Closing Costs

$20,000 required to close

Appraisal Gap Requirements

$500,000 Price

$480,000 Appraisal

$465,600 Loan Amount (Max 97%)

$34,400 Down (6.88% of Price, 3% of Value)

$5000 Closing Costs

$39,400 required to close

The result is an unqualified buyer who does not have enough qualified closing funds to perform on the contract price of $500,000. The loan gets denied and the buyer is forced to cancel. This is the primary reason seller’s are concerned with the appraisal gap and ensuring they accept an offer from a buyer who is still able to qualify with an appraisal gap.

If you are a competitive buyer in a market with rising valuation, then solving the appraisal gap issue is a key component for obtaining a winning bid. Currently, the appraisal gap is the primary challenge for homebuyer’s across the country in 2022, and is especially challenging for first time home buyers or anyone with a low down payment. If you are having this challenge and losing contracts, don’t give up because Assist Home Loans has solutions and strategies to help you win!

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In what ZIP code are you thinking of buying?

What Buyers Can Do to Solve the Appraisal Gap

Strategy #1 – Become Your Own Bank Using a Retirement Account Loan

Many people don’t know you can use a loan against most retirement plan accounts to purchase a primary residence. This option is a way to bolster your down payment and closing cost options with an infusion of additional cash. The loan from your own retirement account does not count as secondary financing and the monthly payment is not counted against the borrower for qualifying purposes in most cases. Best of all, the interest and principal payments are applied back to your own retirement account and not to the bank. So why borrow money from a bank when you can become your own bank?

This additional cash can be used to offset appraisal gap issues and you can typically get up to 50% of the total value of your retirement account via a loan, with a maximum loan amount of $50,000. This general guideline is applicable to most 401k, 457b and 403b plans. 

IRA’s and Roth IRA’s are different and are typically limited to a total of $10,000 available via a penalty free distribution. If the funds are tax deferred going into the IRA, then you’ll need to account for income tax against the distribution. 

Strategy #2 – Preapprove with Option 1 & Option 2

Let’s talk about Buyer B, who has a 20% down payment and is looking to avoid paying mortgage insurance (some form of mortgage insurance is required on all conforming and government loan programs with less than a 20% down payment.) Buyer B is however limited to $105,000 in available, verified closing funds. To solve the appraisal gap, Buyer B will need to utilize a lower down payment option using mortgage insurance to solve the appraisal gap issue.

Using the same example as above, let’s breakdown the required funds to close:

Loan Option 1

$500,000 Price

$500,000 Appraisal

$400,000 Loan Amount

$100,000 Down (20% of Price)

$5000 Closing Costs

$105,000 required to close

Loan Option 2

$500,000 Price

$480,000 Appraisal

$400,000 Loan Amount (Max 97%)

$100,000 Down (20% of Price, 16.67% of Value)

$5000 Closing Costs

$105,000 required to close

You’ll notice that funds to close didn’t change! Buyer B is still able to execute on the contract terms, however, Buyer B will need to qualify by adding mortgage insurance, thus increasing the monthly payment on the loan. Mortgage insurance is available on all conforming loan programs up to the maximum loan to value ratio allowable per program guidelines. Contact us for more detailed information about mortgage insurance options anytime! Below is a breakdown of the mortgage payment for Buyer B in the above example:

Loan Option 1

$500,000 Price

$500,000 Appraisal

$400,000 Loan Amount

4.999% Interest Rate (5.129% APR)

$2147.04 P&I

$520 Property Tax

$75 Insurance

No Mortgage Insurance

Total Payment = $2742.04

Loan Option 2

$500,000 Price

$480,000 Appraisal

$400,000 Loan Amount

4.99% Interest Rate (5.129% APR)

$2147.04 P&I

$520 Property Tax

$75 Insurance

$36.67 Mortgage Insurance

Total Payment = $2778.71

In this case, the appraisal gap is solved by using a lower down payment structure, taking on a mortgage insurance payment, and Buyer B has fulfilled the original contract terms and moves forward with closing.

The key to using option 1 and option 2 to solve appraisal gap issues, is for the loan officer to clearly and effectively communicate to the listing agent and seller that both options have been presented, both are preapproved, and both will close regardless of the potentially lower appraised value. 

Strategy #3 – Remove the Appraisal Contingency/Objection

The third strategy to solve the appraisal gap when making an offer is to remove the appraisal contingency or objection at the time of your offer. This can be done in conjunction with any of the above strategies to give the seller peace of mind that the buyer will not try to renegotiate the price based on a lower appraisal value or cancel the contract. This is not a requirement, but can make your offer significantly stronger to a seller in a multiple offer, competitive situation. 

Keeping other objections/contingencies such as inspection and loan may be prudent, and it’s always a good idea to thoroughly discuss this option and the risks and rewards with your Realtor®. 

For questions or to obtain a free consultation, please schedule an appointment or apply for preapproval below:

Please note that the examples used in this are explanatory and hypothetical. They are not a commitment to lend or guarantee of any kind and the rates, terms, and conditions are subject to change. NMLS 1678642, Equal Housing Lender

By Justin Stearns, NMLS 258870, President & CEO of Assist Home Loans


Justin Stearns is a perennial top producing mortgage originator who began his career in 2003 and has closed well over $1B in residential mortgages. Justin has a B.A. in Economics from UC Davis, holds both a NMLS License #258870 and CA Real Estate Broker’s License # 01504336. Justin was the 2021 Scotsman Guide’s #150 ranked mortgage broker in the nation by volume. 

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