One of the most stressful moments in the home-buying process occurs when a buyer discovers that the property appraisal has come in below the agreed-upon purchase price. This scenario, commonly known as an “appraisal gap,” can throw a wrench into what seemed like a straightforward transaction and leave all parties scrambling for solutions.
Understanding the Appraisal Process
When a buyer is applying for a residential mortgage loan, the lender orders an independent appraisal to determine the property’s fair market value. This is typically a loan requirement and protects the lender from loaning more money than the home is worth. The appraiser is independent and evaluates the property’s condition, location, and features, then compares it to recently sold comparable properties in the area to arrive at a final value. The appraiser is also provided with a copy of the sales contract to reference for their report.
The challenge arises when this professional estimate doesn’t align with the price the buyer and seller have already agreed upon in their contract.
What Happens When the Numbers Don’t Match
When an appraisal comes in low, several immediate consequences follow. First, underwriting will use the lower of the appraised value and purchase price to approve a loan. This means if a buyer agreed to pay $400,000 for a home that appraises for $380,000, the lender will base their loan on the lower amount.
For a buyer putting 20% down, this creates a significant problem. Instead of bringing $80,000 to closing, they would now need to bring $100,000—the original down payment plus the $20,000 gap between the appraisal and purchase price. Many buyers may not have these additional funds available.
Options for Buyers and Sellers
Fortunately, an appraisal gap doesn’t automatically mean the deal is dead. Several options exist for navigating this situation:
Renegotiating the Price: The most straightforward solution involves the seller agreeing to lower the purchase price to match the appraisal. In a balanced or buyer’s market, sellers may be willing to adjust their expectations. However, in competitive markets, sellers who have other interested buyers may be less inclined to budge.
Buyer Covers the Gap: If the buyer truly wants the property and has the financial means, they can bring additional cash to closing to cover the difference. This requires the buyer to have significant assets beyond their planned down payment and closing costs.
Meeting in the Middle: Sometimes, buyers and sellers compromise by splitting the difference. If there’s a $20,000 gap, the seller might reduce the price by $10,000 while the buyer agrees to bring an extra $10,000 to closing.
Challenging the Appraisal: If the buyer and seller believe the appraisal is inaccurate, they can request a reconsideration of value. This involves providing the lender with additional comparable sales data that might support a higher valuation. Alternatively, the buyer can pay for a second appraisal, though there’s no guarantee it will come in higher, and the lender may not accept it.
Walking Away: Most purchase contracts include an appraisal contingency that allows buyers to exit the deal if the appraisal comes in low. This protects the buyer from being forced into a transaction where they’d need to overpay or bring unexpected additional funds. If the buyer walks away under this contingency, they typically receive their earnest money deposit back.
The Market Context Matters
Appraisal gaps became common during the heated real estate markets of recent years, when bidding wars drove purchase prices well above asking. In such scenarios, eager buyers often offered prices that exceeded what recent sales could support, leading to a predictable appraisal deficit.
In cooling markets, appraisal gaps can signal that sellers’ expectations haven’t yet adjusted to changing conditions. The appraisal may reflect the current reality more accurately than the aspirational listing price.
Appraisal gaps can also arise when a property is unique and there are not a lot of comparable sales or data points to help support the recommended value.
The Bottom Line
An appraisal that doesn’t match the contract price isn’t necessarily a deal-breaker, but it does require flexibility, communication, and sometimes creative problem-solving from both parties. Buyers should ensure they understand their contract’s appraisal contingency and have discussions with their lender about options. Sellers benefit from being prepared for this possibility and thinking in advance about their willingness to negotiate.
Ultimately, the appraisal serves as an important reality check in the transaction. While it can be disappointing when the number comes in low, it also protects buyers from overpaying and taking on excessive debt for a property that may not hold its value. With the right approach and reasonable expectations on both sides, most appraisal gaps can be successfully resolved, allowing the transaction to move forward to a successful closing.
