How Much Over Appraisal Should You Pay?

A home appraisal is a key step in real estate transactions, especially when a buyer seeks financing. This independent valuation determines a property’s market value, assuring lenders that the loan is secured by the asset. A challenge arises when the appraised value is lower than the agreed-upon purchase price, impacting financing and the buyer’s out-of-pocket costs.

Understanding Property Appraisals

A property appraisal is a professional, unbiased estimate of a home’s market value by a licensed and certified appraiser. Lenders require this appraisal to mitigate their risk, ensuring that the property’s value supports the loan amount they are extending. The appraiser evaluates numerous factors, including the property’s condition, size, features, and location.

Appraisers also analyze recent comparable sales, examining properties with similar characteristics that have sold in the immediate vicinity. They adjust for differences between the subject property and the comparables, such as lot size, age, condition, and amenities. This provides an independent assessment of value.

What Occurs with a Low Appraisal

When a property appraises for less than the agreed-upon purchase price, an “appraisal gap” occurs. Lenders base their loan amount on the lower of the purchase price or the appraised value.

For example, if a home is under contract for $400,000 but appraises for $380,000, and the buyer plans a 20% down payment, the lender will finance 80% of the $380,000 appraised value ($304,000). The buyer must cover the $20,000 appraisal gap in cash, in addition to their down payment. The buyer brings the total difference between the loan amount and the contract price to closing.

Factors to Consider When Deciding to Pay Over Appraisal

Deciding whether to pay the appraisal gap requires careful consideration of several factors. Current market conditions significantly influence this decision; in a competitive seller’s market with low inventory and high demand, paying over appraisal might be a common practice to secure a desired home. Conversely, in a buyer’s market, the leverage shifts, making such a payment less common.

Your personal financial capacity is paramount, requiring an honest assessment of whether you possess the liquid funds to cover the gap without jeopardizing your financial stability or depleting emergency savings. This extra cash outlay is in addition to your down payment and closing costs. Assessing the property’s unique attributes and desirability is also important; if the home is truly exceptional, in a highly sought-after location, or possesses features that genuinely justify a premium beyond recent comparable sales, the decision might be more palatable.

Consider your long-term plans for the property; if this is intended as a long-term residence, the short-term impact of paying slightly over appraisal may be less significant than if it were a short-term investment. Reviewing the comparable sales data used in the appraisal report is also advisable; sometimes, an appraiser might miss more relevant or recent sales that could support a higher valuation. While emotional attachment can play a role in desiring a specific home, it is prudent to balance this with a pragmatic financial assessment to avoid potential future regrets.

Alternatives When Appraisal is Low

When facing a low appraisal, buyers have several alternatives. One common approach is to renegotiate with the seller, proposing to lower the purchase price to match the appraisal or to meet somewhere in the middle. Sellers may be amenable to this, especially if they are motivated to sell and understand that a new buyer might face the same appraisal challenge.

Another option involves contesting the appraisal, though this process often carries a low probability of success. The buyer, usually through their lender, can submit a “reconsideration of value” request, providing additional comparable sales data or pointing out specific property features the appraiser might have overlooked. This requires strong, objective evidence that was not considered in the initial report.

Finally, if an appraisal contingency clause is included in the purchase agreement, the buyer may have the contractual right to walk away from the deal without losing their earnest money deposit. This contingency provides a safeguard, allowing the buyer to terminate the contract if the appraisal falls below a specified amount. If no such contingency exists or is waived, walking away could result in the forfeiture of the earnest money.

Financial Considerations of Paying Over Appraisal

Paying over the appraised value has immediate and long-term financial implications. The most direct effect is the increased cash required upfront, as the buyer must cover the appraisal gap in addition to their down payment and closing costs. This means more personal funds are tied up in the home.

This decision impacts the loan-to-value (LTV) ratio relative to the appraised value. While the mortgage amount remains fixed based on the appraised value, the buyer’s additional cash contribution for the gap means they are essentially financing a larger portion of the purchase price relative to the property’s objectively determined value. This can affect future refinancing opportunities or the perceived equity in the home.

Starting with less immediate equity is another consequence, as the amount paid over appraisal directly reduces the equity position based on the appraised value. For instance, if you pay $400,000 for a home appraised at $380,000, your starting equity is effectively based on the $380,000 value, not the $400,000 you paid. This situation could become problematic if market values decline, potentially leaving the homeowner “underwater,” where the outstanding mortgage balance exceeds the property’s market value. The risk of being underwater is particularly relevant for short to medium-term plans, as it impacts future resale profitability.