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Homeowners and buyers don’t experience appraisal gaps very often. According to CoreLogic, an appraisal gap occurs about 10% of the time, but that's frequently enough to put it on your radar. Whether you are selling or buying a house, there are beneficial ways to respond to a home appraisal surprise — or prepare in advance.
Dig deeper: Home appraisal — how it works and how much it costs
In this article:
What is an appraisal gap?
An appraisal gap transpires when the estimated home's value is below the contracted sales price. For example, you have a purchase agreement to buy a house at $300,000, yet the appraiser returns a fair market value of only $290,000.
That's a $10,000 shortfall — or “gap” — in the appraised value that can impact the mortgage lender's decision to issue the agreed-upon loan amount. Both the borrower and the seller may immediately want to back out of the deal unless the buyer is willing and able to make a larger down payment to cover the difference.
However, there are options to explore.
Learn more: What is the difference between a house’s appraised value vs. market value?
How the appraisal process works
The appraisal process is anything but perfect. If you experience an appraisal gap, your first instinct may be to order a new appraisal. However, you may be surprised to learn that licensed real estate appraisers are aware of the home's agreed-upon purchase price and, generally, are predisposed to providing a value equal to that number.
Why? Because, even though the buyer pays for the appraisal and the licensed appraiser is an independent and neutral third party, the appraiser is "aligned with the lender," according to 2020 research by Fannie Mae.
Current market conditions and comparable sales for a particular home are likely within a range of prices. Still, the appraiser is required to determine a single value for the property.
"If appraisers believe that any result below contract will extend timelines and create additional frictions, they may be more inclined to provide support for the contract price," the Fannie Mae research said.
That may be why appraisal gaps don't happen more often than they do. And why a new appraisal may not offer a different result — unless a major error was involved.
Read more: Home appraisal bias — how to know if you’re facing discrimination
What can cause an appraisal gap?
However, low appraisals do happen, and first-time home buyers may be the most prone to overpaying for a house, according to CoreLogic. Entry-level homes have the most frequent appraisal gaps, which may be because of the emotions involved in buying a first house.
Another trigger for appraisal gaps: In hot real estate markets with bidding wars, sellers often receive offers above the asking price, leading to low appraisals.
Dig deeper: What happens if an appraisal comes back lower than the offer?
2 contract methods to solve an appraisal gap
By including language in the purchase contract, you can prepare for the possibility of an appraisal gap. There are two primary options.
Appraisal gap coverage clause
If included in a contract, appraisal gap coverage specifies whether the buyer or seller — or both — will make up the difference between the asking price and the appraised value up to a specific dollar limit.
Appraisal gap contingency
An appraisal contingency allows the buyer to walk away from the purchase without penalty if an appraisal gap occurs. As a buyer, it also allows you the ability to open renegotiations on the deal because you are no longer committed to buying the house at the originally agreed purchase price.
Learn more: What is an appraisal contingency, and should you include it in your offer letter?
Have questions about buying, owning, or selling a house? Submit your question to Yahoo's panel of Realtors using this Google form.
Appraisal gap FAQs
Is appraisal gap coverage a good idea?
An appraisal gap coverage clause may be a good idea if you're in a hot, highly competitive market. It specifies how a buyer and seller might cover a low appraisal and to what dollar limit. It may also be a good idea to have appraisal gap coverage in your purchase agreement if you’re a first-time home buyer, since appraisal gaps are most common with new buyers.
What does a $5,000 appraisal gap mean?
This means that the official fair market value of the home you're interested in buying was $5,000 under the contracted purchase price. For example, if you are buying a $300,000 home, the appraisal listed the current market value at $295,000.
What is an example of an appraisal gap coverage clause?
In any legal agreement of this magnitude, it's best to leave the details to a professional, such as your real estate agent or an attorney. However, here's a sample from the Realtors at Great Colorado Homes of the language that could be considered in an appraisal gap clause: "If the property does not appraise for the purchase price, the buyer agrees to pay up to $20,000 above the appraised value, but not to exceed the purchase price."
Can the buyer back out on an appraisal gap?
Most purchase agreements specify that a buyer can back out of buying a home if financing with the mortgage lender falls through. An appraisal gap could cause this to happen, though whether or not you get some or all of your earnest money back might be in question. However, a specific appraisal gap contingency clause would eliminate the doubt.
This article was edited by Laura Grace Tarpley.
