What Happens If an Appraisal Is Lower Than the Loan Amount?

When a home appraisal is lower than the agreed-upon purchase price or desired loan amount, it creates a common situation in real estate. A home appraisal provides an independent assessment of a property’s market value. This evaluation is a fundamental step for buyers and mortgage lenders. Lenders rely on the appraisal to confirm the property’s value aligns with the loan amount, safeguarding their investment by ensuring the collateral covers the loan.

Defining an Appraisal Gap

An “appraisal gap” occurs when a licensed appraiser’s valuation of a property is less than the price the buyer and seller agreed upon in the sales contract. This disparity is significant from a lender’s perspective, as they typically only lend based on the appraised value, not the higher contract price. The difference directly impacts the loan-to-value (LTV) ratio, a key metric lenders use to assess mortgage risk. A higher LTV ratio due to a low appraisal can make a lender hesitant to provide the full loan amount.

Several factors can contribute to a low appraisal. In rapidly appreciating markets, agreed-upon sales prices may outpace recent comparable sales data used by appraisers. Unique property features that do not broadly appeal to the market, or an appraiser overlooking recent home improvements, can also lead to a lower valuation. An appraiser might also use outdated information or comparables not truly similar in size, condition, or location.

Buyer Actions to Address a Low Appraisal

When faced with a low appraisal, a homebuyer has several actions to keep the transaction moving. One approach is for the buyer to cover the appraisal gap in cash. This means paying the difference between the appraised value and the purchase price. This option requires the buyer to have sufficient liquid funds beyond their down payment and closing costs.

Alternatively, the buyer can renegotiate the purchase price with the seller, proposing to lower it to align with the appraised value or meet in the middle. This renegotiation is often the first step, especially if the contract included an appraisal contingency. Buyers might also request seller concessions or credits, where the seller contributes funds towards the buyer’s closing costs. These concessions can free up the buyer’s cash to help cover the appraisal gap.

A buyer could also consider pursuing a different loan product or a new lender, though this is less common and can delay closing. This approach might be explored if the appraisal issue seems tied to the specific lender’s risk assessment or chosen appraiser. If negotiations fail and the buyer cannot cover the gap, and an appraisal contingency is in place, the buyer typically has the option to withdraw from the contract without losing their earnest money deposit.

Seller Actions to Address a Low Appraisal

Upon receiving a low appraisal, a home seller has several actions to address the situation. A direct option is for the seller to reduce the sale price to match the appraised value. This ensures the lender will finance the full amount.

The seller might instead offer a credit to the buyer to help cover the appraisal gap or assist with closing costs. This approach can make up part of the difference and incentivize the buyer to proceed with the original purchase price. Seller concessions are typically capped by loan type, with limits varying for conventional and government-backed loans.

In some instances, a seller may refuse to adjust the price or offer concessions, especially in competitive markets where other buyers might be willing to cover the gap. This stance can lead to the buyer covering the entire difference or the deal falling through if no compromise is reached. Often, sellers and buyers work together to find a compromise, such as splitting the appraisal gap, to keep the transaction on track.

Challenging an Appraisal

When an appraisal comes in lower than expected, parties can formally challenge the valuation. The process begins with a review of the appraisal report to identify errors or omissions. This review should look for factual inaccuracies regarding property characteristics, such as square footage, number of rooms, or overlooked renovations.

Another step involves gathering additional comparable sales data the appraiser might have missed or undervalued. These comparables should be recent sales of similar properties in the immediate vicinity supporting a higher valuation. Once supporting evidence is compiled, a formal “Reconsideration of Value” (ROV) request is submitted to the lender, who communicates with the appraiser.

The ROV process allows the appraiser to review the new information and potentially revise their original valuation. The ROV is not a guarantee of a higher value, and appraisers are expected to maintain impartiality. While less common and often at the buyer’s or seller’s expense, a new appraisal might be ordered if significant discrepancies persist or the original appraisal is deemed unreliable.

Navigating Loan and Transaction Impacts

A low appraisal can impact the loan agreement and closing process, even after initial actions to address the gap. The primary impact is on the loan-to-value (LTV) ratio, as lenders base the maximum loan amount on the appraised value. If the appraised value is lower than the purchase price, the lender will reduce the loan amount, increasing the buyer’s required cash contribution.

This often necessitates a larger down payment from the buyer to bridge the difference between the reduced loan amount and the agreed-upon purchase price. If the LTV ratio remains high after the appraisal, typically above 80%, the buyer may also be required to pay private mortgage insurance (PMI), adding to their monthly housing expenses. PMI protects the lender in case of borrower default and is usually removed once sufficient equity is built.

Renegotiations or an appraisal challenge can extend the closing timeline by several days to a few weeks. The purchase agreement’s appraisal contingency plays a significant role, determining the buyer’s ability to renegotiate or withdraw without penalty. Understanding these financial and procedural consequences helps buyers and sellers navigate the complexities that arise after a low appraisal.