Where Does Appraisal Gap Money Go & Who Pays?

An appraisal gap occurs in a real estate transaction when the appraised value of a home is lower than the agreed-upon purchase price. This situation frequently arises due to market conditions like rapidly rising home prices, competitive bidding wars, limited comparable sales, unique property features, or appraisal errors. When a home appraises for less than the contract price, it creates a financial challenge that must be addressed for the sale to proceed.

Funding the Appraisal Gap

When an appraisal gap surfaces, the most common method for bridging the difference involves the buyer bringing additional cash to the closing table. This cash payment covers the shortfall between the appraised value and the contract price. For instance, if a home is under contract for $450,000 but appraises for $425,000, the buyer would need to provide an extra $25,000 in cash.

This additional cash is not a separate fee paid to an outside party; it becomes part of the buyer’s total equity contribution, integrating with their original down payment and increasing their total cash outlay. Lenders will only finance a loan up to the appraised value of the property, not the higher contract price. This is because the appraisal provides an independent assessment of the home’s market value, which lenders use to protect their investment in case of buyer default.

Impact on Buyer Funds and Loan

An appraisal gap directly increases the buyer’s overall cash requirements at closing. Since the mortgage lender will only finance the lesser of the appraised value or the purchase price, the loan amount remains tied to the lower appraised value. The buyer’s cash payment then makes up the difference, ensuring the total funds for the purchase price are met.

By paying the appraisal gap in cash, the buyer immediately gains more equity in the home from the outset of ownership. Their increased cash contribution translates directly into a larger ownership stake relative to the total purchase price. This additional equity can serve as a financial buffer, though it also means the buyer has committed more of their liquid assets upfront. The funds used to cover the gap become part of the overall transaction funds managed by the escrow or closing agent, contributing to the seller’s net proceeds and establishing the buyer’s initial equity position.

Seller Side Adjustments and Negotiation

In situations involving an appraisal gap, the seller also has several options to facilitate the sale, which can influence the flow of funds and the financial outcome for both parties. One common resolution involves the seller agreeing to reduce the purchase price to match the appraised value. In this scenario, no “appraisal gap money” is exchanged; instead, the contract price is simply adjusted downwards, directly impacting the seller’s net proceeds from the sale. This approach is more likely in a cooling market or if the seller is motivated to close quickly.

Another alternative involves seller credits or concessions, where the seller offers a financial contribution to the buyer at closing. These credits, often applied towards the buyer’s closing costs, effectively reduce the amount of cash the buyer needs to bring for those expenses. For instance, a seller might offer a credit of $5,000 towards closing costs, allowing the buyer to reallocate their own funds to cover a portion of the appraisal gap or simply reducing their overall out-of-pocket expenditure. Lenders typically place limits on these credits, often a percentage of the sales price, such as 3% to 9% for conventional loans depending on the buyer’s down payment.

A middle-ground approach involves the buyer and seller agreeing to split the appraisal gap. For example, if there’s a $10,000 gap, the seller might reduce the price by $5,000, and the buyer covers the remaining $5,000 in cash. This shared responsibility reduces the financial burden on any single party. In these scenarios, the necessary funds are either eliminated through a price reduction or offset by seller contributions within the closing statement, ultimately impacting the final distribution of funds at the time of closing.