An appraisal gap describes the difference between the sales price and the lower amount of the appraisal required by the mortgage being obtained by the buyer. It becomes an issue if the seller is not willing to lower the price or the buyer is not willing to pay the difference in cash.
Looking at the issue from the seller's perspective, "if the buyer wants my home and he can't get the loan he wants, he'll have to make up the difference in cash." The buyer might have a different view like "If an independent appraiser can't justify the price, I'm not going to pay more than appraised value."
- Pay the difference in the appraised value and the purchase price in cash.
Solution - Assuming the buyer has adequate cash reserves and is willing to pay above appraised value, this will satisfy the lender. - Decrease your down payment percentage to apply toward the appraisal gap. It may trigger mortgage insurance which will increase your payment.
Example:
$400,000 Sales Price with 20% down payment of $80,000; Home appraises for $390,000
Possible solution ... buyer could take $10,000 of the $80,000 he was going to use for the down payment and make up the gap. That only leaves him $70,000 which is a good downpayment for this size home, but it may require that he pay mortgage insurance because the loan-to-value is more than 80%. - Renegotiate the contract with the seller. Assuming both parties are willing to negotiate on the terms, the seller could lower the price to the appraised value, or any other number of possibilities.
- Include an appraisal gap clause - "Buyer and seller agree that if the appraised value comes in lower than the purchase price, buyer agrees to pay up to $XX,000 above appraised value, but not exceeding the purchase price."
An appraisal gap clause addresses what the buyer is willing to do within the parameters included. It provides limited comfort to both the seller and buyer to address the issue of the home appraising for a lower amount than necessary. This clause provides a way for the buyer to compete in a seller's market. - Terminate the contract.
Appraisals can be a confusing but necessary part of the process when the buyer needs a mortgage. I'm available to answer any questions and share our experience with you. Our goal is to be your source of real estate information.