What Is an Appraisal Gap in Real Estate?

An appraisal gap is a financial discrepancy in real estate, occurring when a property’s appraised value falls short of the agreed-upon sale price. This difference can impact the transaction’s progression. Understanding this concept is important for anyone involved in real estate, as it can introduce unexpected financial considerations and affect the deal’s success.

Defining Appraisal Gap

An appraisal is an unbiased, professional opinion of a property’s value, conducted by a licensed appraiser. The appraiser evaluates the home’s condition, features, and recent comparable sales. Lenders require an appraisal to ensure the property’s value supports the loan amount, protecting their investment.

An appraisal gap occurs when the appraiser’s valuation is less than the agreed-upon contract price. For example, if a home is under contract for $400,000 but appraises for $380,000, a $20,000 gap exists. This discrepancy is important because lenders base the maximum loan amount on the appraised value or contract price, whichever is lower. Thus, a lower appraised value directly affects the buyer’s financing.

Factors Contributing to an Appraisal Gap

Market dynamics and property characteristics contribute to appraisal gaps. In hot real estate markets, demand often outstrips supply, leading to bidding wars. Buyers may offer prices significantly above the asking price, sometimes exceeding what an appraiser can justify based on historical comparable sales. These aggressive offers, driven by buyer enthusiasm, can push contract prices beyond the property’s immediate appraised value.

Properties with unique or hard-to-value features also challenge appraisers. Limited comparable sales for homes with unusual architectural styles, extensive custom renovations, or specific locations can lead to conservative valuations.

Appraiser methodology prioritizes data from closed transactions. This methodical approach ensures objectivity but can result in an appraised value that lags behind current market willingness to pay, creating a gap.

Impact on Real Estate Transactions

An appraisal gap alters the financial landscape for buyers and sellers. Lenders approve loans based on the lower of the contract price or appraised value. If the appraisal is below the contract price, the lender finances only up to the appraised amount, making the buyer responsible for the difference.

This increases the buyer’s out-of-pocket costs. The buyer may need to bring additional cash to closing to cover the gap, beyond their down payment and closing costs. For example, if a $400,000 contract appraises for $380,000, and the buyer has a 20% down payment on the appraised value ($76,000), they would also need to cover the $20,000 gap in cash.

For sellers, a gap can reduce expected net proceeds. If the seller lowers the price to match the appraisal, they receive less. If the buyer cannot cover the gap, the transaction may fail, forcing the seller to relist. An appraisal contingency, common in purchase agreements, protects the buyer, allowing renegotiation or withdrawal without penalty if the appraisal is insufficient.

Navigating an Appraisal Gap

When an appraisal gap occurs, buyers and sellers have several options.

Buyer Covers the Difference

The buyer can cover the difference between the appraised value and the contract price. This requires the buyer to bring additional cash to closing, beyond their planned down payment and closing costs.

Seller Reduces Price

Alternatively, the seller might agree to reduce the sale price to match the appraised value. This lowers the purchase price to the amount the lender will finance.

Negotiate a Split

Buyers and sellers often negotiate to split the difference. For example, for a $10,000 gap, the seller might reduce the price by $5,000, and the buyer pays an additional $5,000 in cash.

Challenge the Appraisal (Reconsideration of Value – ROV)

Challenging the appraisal, known as a Reconsideration of Value (ROV), is another option. The buyer, typically through their lender, submits a formal request to the appraiser to re-evaluate their findings. This request must be supported by compelling evidence, such as recent comparable sales not considered, overlooked property improvements, or factual errors in the report. The lender reviews the evidence and forwards it to the appraiser, who decides whether to revise the valuation. This process can take days to weeks and must be completed before loan closing.

Terminate the Transaction

If no mutually agreeable solution is reached and an appraisal contingency is in the purchase agreement, the buyer may terminate the transaction. This allows the buyer to withdraw without financial penalty, preserving their earnest money deposit.