What Is an Appraisal Gap Clause in Real Estate?

In competitive real estate markets, securing a property often requires strategic considerations beyond the initial offer. A standard step in nearly all real estate transactions involving financing is the home appraisal, which determines a property’s market value. This assessment safeguards both the buyer and the mortgage lender, ensuring the loan amount aligns with the property’s worth. As markets intensify with multiple offers and rising prices, an “appraisal gap clause” has emerged to navigate potential valuation discrepancies.

What an Appraisal Gap Clause Is

An appraisal gap clause is a provision within a real estate purchase agreement that addresses situations where a home’s appraised value is less than the agreed-upon purchase price. This clause clarifies a buyer’s commitment to cover the difference if such a gap occurs. It formalizes an understanding between the buyer and seller.

The clause has become more common in competitive markets where demand for homes exceeds inventory. In these conditions, bidding wars can push offer prices above what an appraiser determines as market value. Including this clause demonstrates a buyer’s serious intent and preparedness to proceed with the transaction even if an appraisal shortfall arises.

How an Appraisal Gap Clause Works

An appraisal gap clause involves a pre-agreed financial commitment from the buyer. Typical language specifies that the buyer will pay a certain amount “above the appraised value, but not to exceed the purchase price.” This sets a maximum limit on the buyer’s additional out-of-pocket expense.

Following an accepted offer, the mortgage lender orders an appraisal. If the appraisal comes in lower than the contract price, the clause dictates how the buyer will cover the difference. For example, if a home is under contract for $500,000 but appraises at $480,000, and the clause states the buyer will cover up to $15,000 of an appraisal gap, the buyer would bring an additional $15,000 to closing, making their effective purchase price $495,000. The remaining $5,000 gap would then need to be renegotiated or the transaction could be jeopardized.

The clause ensures the transaction proceeds without renegotiation or termination, provided the gap falls within the buyer’s committed amount. This commitment is significant because mortgage lenders only finance the loan amount based on the appraised value or the purchase price, whichever is lower.

Considerations for Buyers

For buyers, committing to an appraisal gap clause carries direct financial implications, requiring additional cash at closing. Mortgage lenders base loan amounts on the home’s appraised value, not the purchase price. If the appraisal comes in low, the buyer must cover the gap with funds beyond their down payment and closing costs.

This additional cash outlay can impact a buyer’s liquidity and financial planning. For instance, if a buyer agrees to a $400,000 purchase with a 20% down payment, and the home appraises at $380,000, the lender will only finance 80% of $380,000 ($304,000). The buyer would then need to cover their initial $80,000 down payment plus the $20,000 appraisal gap, totaling $100,000 in cash.

Understanding their capacity to cover such a gap is important before including this clause in an offer. The clause also affects the loan-to-value (LTV) ratio, as the loan amount is tied to the lower appraised value, potentially requiring a larger cash contribution.

Considerations for Sellers

When a seller receives an offer with an appraisal gap clause, it provides greater assurance regarding the sale price. This commitment signals a willingness to complete the transaction, even if the appraisal falls short. This reduces uncertainty during the appraisal stage.

An appraisal gap clause also makes an offer more attractive and competitive, particularly in multiple-offer scenarios. It indicates the buyer is prepared to address a common hurdle, minimizing the risk of the deal falling through due to appraisal issues. This commitment streamlines the selling process and provides greater confidence the agreed-upon price will be realized.