In today’s real estate market, low inventory and high demand are driving up home prices. As many as 54% of homes are getting offers over the listing price, based on the latest Realtors Confidence Index from the National Association of Realtors (NAR). Shawn Telford, Chief Appraiser at CoreLogic, elaborates:
“The frequency of buyers being willing to pay more than the market data supports is increasing.”
While this is great news for today’s sellers, it can be tricky to navigate if the price of your contract doesn’t match up with the appraisal for the house. It’s called an appraisal gap, and it’s happening more in today’s market than it has in the past.
What Is An Appraisal Gap?
An appraisal gap is the difference between the appraised value of a home and the purchase price in the sales contract.
An appraisal is an opinion of value by a licensed real estate appraiser. Once a home is under contract and passes the home inspection process, the mortgage lender will order an appraisal. The assigned appraiser will then visit the property to do a visual inspection, compare the features of the home against recently sold properties in the area, and prepare an appraisal report.
The buyer’s lender won’t loan them more than the house’s appraised value. So, if the appraised value of the home comes in below the contract price, there is going to be a gap between the amount of loan the buyer can secure and the amount they must pay for the house.
The appraisal process is critical to protecting the lender from over-lending while also protecting the buyer and seller from having the deal fall apart. However, since appraisals are opinions, they have a margin for error. You may hire three separate appraisers for the same property and receive three different estimates of value.
This tension is one of the most complex parts of the real estate transaction. Appraisers are responsible for helping lenders determine safe loan limits. This is a difficult task during extreme markets like we are in today.
How Big of A Problem Are Appraisal Gaps Today?
According to recent data from CoreLogic, 19% of homes had their appraised value come in below the contract price in April of this year. That’s more than double the percentage in each of the two previous Aprils.
The chart below uses the latest insights from NAR’s Realtors Confidence Index to showcase how often an issue with an appraisal slowed or stalled the momentum of a house sale in May of this year compared to May of last year.
According to the data, 26% of purchases that ran into an appraisal issue experienced significant delays, while 13% resulted in the sale completely falling through.
Why are So Many Appraisals Coming in Low Today?
Appraisers use historical sale data to determine home value – typically going back as far as six months to find comparable homes in the area. The problem with this strategy is that the value of the home that the seller is setting is based on today’s value…and there’s a gap between today’s value and the comparables that the appraiser has chosen over the previous six months. That gap oftentimes results in the appraised value being lower than the current value the seller is willing to sell for.
How Can You Prepare for an Appraisal Gap?
Because appraisal gaps are happening so often, it is vital you put a plan in place to navigate a discrepancy should it arise. An Appraisal Gap strategy will show you how to make the numbers work and still be able to buy your home if the appraisal comes in a little bit low.
What is an Appraisal Gap strategy? Let’s say, for example, you are purchasing a home listed for $800,000 and putting 20% down. However, the home only appraises for 10% less that the listed price at just $725,000.
In this scenario, employing an Appraisal Gap strategy means your lender can restructure your purchase contract from a 20% down payment to a 10% down payment. This means the 10% that was going to be used as a down payment can now be used to cover the appraisal gap.
By reallocating the down payment and buying out the mortgage insurance, you can see the cash to closing is actually a bit less than what it would have been originally, and the monthly payment is only $18 more. A small price to pay for eliminating delays and risking the deal falling through in today’s ultra-competitive housing market!
The example above is just one of many ways low appraisals can be planned for and handled. Appraisal gaps are becoming more common as home appreciation continues to rise and competition for housing intensifies. However, a low appraisal does not have to end in a canceled deal – it just means you have to pivot and renegotiate.
To help you navigate today’s competitive housing market, NEO Home Loans has created a program called the Bulletproof Buyer program. It’s a four-step process that makes you the most likely potential buyer to get into a home and gives you an unfair advantage if you’re competing in the housing market. The program includes creating a solid Appraisal Gap strategy at the beginning of the loan process so if your appraisal does come in low, you are prepared to pivot and continue your home purchase without any delays.
If you would like to learn more about how we handle appraisal gaps, or would like advice on planning for them in the future, fill out the form below to request a Bulletproof Buyer program consultation with one of our mortgage advisors.