Appraisal gaps and how to prepare for them as a buyer

What Is An Appraisal Gap?

Appraisals are opinions of value given by a licensed appraiser. Mortgage lenders will require an appraisal report in order for a buyer to secure financing for a home.

Appraisal gaps are the difference between the contract purchase price and the appraised value of a home.

Once a home is under contract and passes all necessary home inspections, appraisers go out to the property and preform a visual inspection. They take into account recent sales in the neighborhood, comparable properties, condition of the home, and any upgrades that may have been recently completed. Once the inspection is completed, the appraiser will then put together a report and assign the home a value.

Lenders will not loan more than the appraised value of a home. Although sometimes frustrating, the appraisal process helps safeguard everyone involved in the transaction. This keeps lenders from over-lending while also protecting the buyer and seller.

The tricky thing about appraisals is that since they are an opinions of value - errors do occur and things get missed. If multiple appraisers were hired to inspect the same house, there is a chance that you could get a slightly different value from each appraiser. At the end of the day, human error is inevitable.

This tension is one of the most complex parts of the real estate transaction. Appraisers are responsible for helping lenders determine safe loan limits. This is a difficult task during extreme markets like we are in today.

How Big of A Problem Are Appraisal Gaps Today?

According to recent data from?CoreLogic,?19%?of homes had their appraised value come in below the contract price in April of this year. That’s?more than double?the percentage in each of the two previous Aprils.

The same set of data revealed 26% of purchases that ran into issues with the appraisal experienced significant delays in the home buying process. What's even crazier than that? 13% of those transactions completely fell through.

Oftentimes, appraisers must rely on data that dates back as far as six months. With home values rising at historical levels, a property that sold six months ago may no longer be a fair comparable.

How Can You Prepare for an Appraisal Gap?

Appraisal gaps can be deal killers, so it is crucial that a buyer has a strategy in place should the appraised value come back short of the purchase price.

Let's explore how an appraisal gap strategy can effectively be used. The situation below shows a scenario of an $800,000 purchase price with a 20% down payment. What do you do if the appraisal comes in $75,000 short? Thankfully, there are a few options.

Above, you can see an example of an Appraisal Gap strategy where the lender simply restructured the loan from a 20% down payment to a 10% down payment. What this means is that the 10% that was going to be used as a down payment can now be used to mitigate the appraisal gap (the portion the lender will not finance).

As you will notice, several things changed once the down payment changed. When a buyer goes from a 20% down payment to a 10% down payment, they will be subject to paying private mortgage insurance. In this instance, the buyer elected to choose single premium mortgage insurance - the mortgage insurance was rolled into the buyer's loan amount. Another thing that you will notice is that the higher loan amount will cause a slight increase to principal and interest as well as insurance premiums.

Conclusion

The example above is just one of the ways short appraisals can be planned for and dealt with. As homes continue to appreciate at historic levels and appraisal gaps start to become more common, many buyers will find themselves having to pivot or negotiate. With a sold appraisal gap strategy, buyers avoid the stress of having their deal fall apart. As they say, hope for the best, but plan for the worst.

Give me a call to schedule a mortgage planning session or to discuss an appraisal gap strategy today!

Happy shopping!