Financial Planning and Analysis

What Happens If Home Appraisal Is Lower Than Offer?

Discover how to navigate a low home appraisal. Learn buyer and seller options, from renegotiation to resolution, to save your real estate deal.

A home appraisal is an assessment by a licensed professional to determine a property’s fair market value. Lenders primarily use this valuation to ensure the mortgage amount is justified by the home’s actual worth. While the appraisal process typically occurs after a buyer’s offer is accepted, the appraised value might come in lower than the agreed-upon purchase price. This situation, known as an appraisal gap, can introduce complexities, affecting buyer financing and necessitating further discussions.

Understanding the Appraisal Gap’s Significance

A low appraisal presents a challenge in a real estate transaction because mortgage lenders base the maximum loan amount on the lower of the property’s appraised value or the agreed-upon purchase price. If a home appraises for less than the offer, the lender will only finance up to the appraised value. For instance, if a home is offered at $400,000 but appraises at $380,000, a lender requiring a 20% down payment would calculate the loan based on $380,000, not $400,000.

This scenario directly impacts the buyer’s loan-to-value (LTV) ratio. A higher LTV ratio can result from a low appraisal, potentially requiring the buyer to make a larger down payment than initially planned, or it could lead to a loan denial if the buyer cannot cover the difference. An appraisal contingency, a provision in purchase agreements, protects buyers by allowing them to renegotiate the price or withdraw from the contract without penalty if the appraisal is insufficient. This contingency dictates the buyer’s flexibility and obligations.

Buyer’s Available Courses of Action

When faced with a low appraisal, a buyer has several options. The buyer can cover the difference between the appraised value and the offer price in cash. This requires available liquid funds, which can be a substantial sum depending on the appraisal gap’s size. This option allows the transaction to proceed without renegotiation but demands additional financial outlay beyond the initial down payment and closing costs.

Another option is to renegotiate the purchase price with the seller, requesting a reduction to match the appraised value. This involves direct communication and negotiation, often facilitated by real estate agents, to reach a mutually agreeable price. The seller’s willingness to reduce the price often depends on market conditions and their motivation to sell.

If the purchase agreement includes an appraisal contingency, the buyer can exercise this right to terminate the agreement. This allows the buyer to walk away from the deal and recover their earnest money deposit without penalty if the seller does not agree to a price adjustment. This contingency serves as a protective measure, ensuring the buyer is not obligated to overpay for a property.

A buyer can also challenge the appraisal through a process called “Reconsideration of Value” (ROV). The buyer or their agent must gather specific information to support a higher valuation. This includes identifying recent comparable sales the appraiser might have overlooked, detailing property upgrades not adequately noted, or pointing out factual errors within the appraisal document. This information is submitted to the lender, who forwards it to the appraiser for review; the buyer does not directly contact the appraiser.

Seller’s Available Courses of Action

A seller also has options when a low appraisal occurs. The seller can agree to lower the sale price to match the appraised value, often done to keep the transaction moving and avoid relisting the property. This decision may be influenced by how quickly the seller needs to complete the sale or by current market conditions.

Alternatively, the seller can hold firm on the original offer price, requiring the buyer to cover the appraisal gap in cash. This approach carries the risk that the buyer may not have the necessary funds or may choose to terminate the contract, leading to the property being relisted.

If the buyer cannot or will not cover the appraisal gap and an appraisal contingency is invoked, the seller may agree to terminate the contract. While sellers prefer to avoid this outcome, it can become a necessity if no compromise is reached, allowing both parties to move on.

Similar to buyers, sellers can also challenge a low appraisal by requesting a Reconsideration of Value (ROV). The seller or their agent should compile details about recent property improvements, energy-efficient upgrades, or comparable sales that may have been undervalued or missed by the appraiser. This information is typically submitted through their real estate agent to the buyer’s lender, who facilitates the review.

Reaching a Resolution

Navigating an appraisal gap often requires negotiation to find a mutually agreeable resolution. Compromises include the seller agreeing to a partial price reduction, where the new price falls between the original offer and the appraised value. In such cases, the buyer would then be responsible for paying the remaining difference in cash.

Another compromise involves the seller offering credits towards closing costs, which can help offset some of the buyer’s out-of-pocket expenses, even if the sale price is not fully reduced to the appraised value. Clear communication and collaboration between both parties and their real estate agents are important throughout this negotiation. Real estate agents play a role in facilitating these discussions and exploring options.

Once a resolution is reached, it is documented through an amendment to the original purchase agreement, which both the buyer and seller must sign. This amendment modifies the contract to reflect new terms, such as a revised purchase price or seller concessions. If no mutually agreeable resolution can be found, the contract may be terminated, with the buyer walking away and the property returning to the market. This outcome can lead to delays and financial strain for both parties. Upon resolution, the lender re-approves the loan based on the adjusted terms, allowing the transaction to proceed towards the closing date.

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