Homebuying can sometimes feel like a whirlwind of numbers and negotiations. Amidst all the chaos, the two figures that hold the most weight are the agreed-upon purchase price and the home’s appraised value. But what happens when these two numbers don’t align? That’s where appraisal gap clauses come into play. In this article, we’ll delve into the world of appraisal gap clauses, exploring what they are, how they work, and the options available to complete your dream home purchase.
What is an Appraisal Gap?
An appraisal gap occurs when the agreed-upon purchase price exceeds the appraised value of the home. This situation often arises in fast-paced real estate markets, where bidding wars drive prices up rapidly. While an appraisal gap can complicate the sale process, it doesn’t necessarily mean the end of the road. You have several options to navigate through this challenge and keep your homebuying journey on track.
How Do Appraisal Gaps Work?
In a real estate purchase and sale agreement (PSA), the purchase price is specified as the amount both the buyer and seller agree the home is worth. If you’re financing the purchase with a mortgage, the lender requires an appraisal to ensure the price aligns with the property’s value. The appraisal determines the home’s worth based on recent sales of similar properties in the area.
If you find yourself faced with an appraisal gap, here are your options:
Renegotiate with the Seller
You can ask the seller if they’re willing to lower the price to match the appraised value or find a middle ground. For example, if there’s a $20,000 appraisal gap, the seller could reduce the price by $10,000, and you could increase your down payment by the same amount. Keep in mind that this option may not be viable in a competitive seller’s market or if the seller has other offers on the table.
Pay the Difference in Cash
If you’re a cash buyer, you have the option to pay the additional amount out of pocket. However, if you’re relying on a mortgage, you’ll need to bring extra cash to the closing table – the down payment plus the appraisal gap amount. Some lenders offer programs that allow for a lower down payment, but you may incur extra charges like private mortgage insurance (PMI).
Dispute the Appraisal
If you disagree with the appraised value, you can dispute it in writing. However, to successfully challenge the appraisal, you’ll need to provide supporting evidence. This could include pointing out discrepancies in the appraiser’s methodology, missed home features or upgrades, miscalculations in the property’s living area, or even flaws in the appraisal process itself.
Walk Away
If you have an appraisal contingency in your contract, you can choose to walk away from the deal. In this case, you’ll typically retain your earnest money, which is a deposit you provide to show your commitment to buying the home. However, without an appraisal contingency, you may forfeit this deposit.
Appraisal Gap Example
Let’s paint a picture with an example. Imagine you’re interested in purchasing a home with an asking price of $400,000. You submit an offer for the full amount, and it gets accepted by the seller. However, the lender’s appraiser determines that the home is worth only $380,000, leaving you with a $20,000 appraisal gap.
The next steps depend on whether your PSA includes appraisal gap coverage, an appraisal gap clause, or an appraisal contingency. These terms may sound similar, but they have distinct implications:
Appraisal Gap Coverage vs. Appraisal Contingency
Appraisal gap coverage obligates you, the buyer, to purchase the home at the agreed-upon price, even if the appraisal falls short. On the other hand, an appraisal gap clause stipulates that you agree to bridge the gap between the appraised value and the purchase price, up to a specified amount. This clause provides some flexibility, acting as a middle ground between appraisal gap coverage and an appraisal contingency.
An appraisal contingency offers you the right to cancel the contract and retain your earnest money if the appraisal is lower than the agreed-upon price. Earnest money is typically around 1% to 3% of the purchase price and demonstrates your seriousness as a buyer. Without an appraisal contingency, you risk forfeiting this deposit.
When Is an Appraisal Gap Clause Necessary?
In a competitive seller’s market, an appraisal gap clause can make your offer more appealing to sellers. It assures them that the sale can proceed, even if the appraisal comes in lower than expected. This is particularly crucial in hot real estate markets where bidding wars drive prices sky-high. Make sure the appraisal gap clause in your agreement clearly outlines how much you’re willing to pay above the appraised value or how you and the seller plan to handle the difference.
Frequently Asked Questions (FAQs)
What happens if you waive the appraisal contingency?
Waiving the appraisal contingency can strengthen your offer in a highly competitive market. By doing so, you give up your right to cancel the contract and receive your earnest money back if the appraisal falls short of the purchase price. However, keep in mind that if the appraisal is low and you’re unable or unwilling to bridge the gap, you risk losing your earnest money.
Can the buyer back out with an appraisal gap clause?
If you have an appraisal gap clause in your agreement, backing out becomes more difficult. This clause binds you to purchase the home, even if the appraisal falls short. If you decide to walk away, you may forfeit your earnest money, and in rare circumstances, the seller could pursue legal action for breach of contract.
Should you pay over the appraised value?
In the heat of a bidding war, it’s easy to get caught up and consider paying more than the appraised value for a home. Before making such a decision, pause and consider a few factors:
- Is this truly your dream home, or are you driven by fear of missing out?
- Can you comfortably afford the additional cash required to bridge the gap?
- Will you be able to recoup your investment if you decide to sell the home in the near future?
If you genuinely love the home and are financially prepared for the added costs, paying over the appraised value might be a justifiable step towards securing your dream home.
Remember, the world of homebuying can be complex, and appraisal gaps are no exception. Being well-informed about your options and having a clear understanding of your contract’s appraisal gap clause or contingency will help you navigate the process with confidence.
For more helpful advice on personal finances and everything related to your financial well-being, visit Personal Finances Blog. Happy homebuying!