Appraisal Gap | How to Use it to Get Under Contract
To borrow a phrase from Kermit the frog, “it’s not easy being green.”
And in Denver these days, it’s really not easy being a homebuyer.
Low interest rates, rock bottom inventory, and a competitive marketplace have forced motivated homebuyers to take off the gloves and get incredibly creative when it comes to making an offer. “List price” is usually the starting point. Bidding wars are typical; buyers are looking for any potential edge to make their proffer stand out.
One of the best methods of making your bid attract attention involves the home appraisal and the potential “gap” that may occur.
What is a Home Appraisal and Why is it Necessary?
A home appraisal is required by a homebuyer to fulfill the requirements when obtaining a mortgage loan. This is done once a property is under contract. The appraisal is necessary to confirm that the sales price is fair to everyone involved: the buyer, the seller, and the lender. The lender needs assurance that the property is valued appropriately in order to approve the requested loan amount.
When a home appraisal is conducted the appraiser is looking at a multitude of factors. In addition to examining the comparable properties that have sold in the immediate area, they consider the following: zoning, lot size, location, utilities, home characteristics, square footage, number of bedrooms and bathrooms, basement/crawl space, unique features, general condition of the property, outdoor spaces, etc.
The Appraisal Gap and What it Means to the Home Seller/Buyer
Be aware there are some situations where the appraisal price comes in lower than the agreed upon price. This is especially true in a fast-paced sellers’ market where appraisals can’t keep up with average and median sales prices that keep rising. This appraisal gap is the difference between the appraisal and the contract price. To cover the difference, the home buyer agrees to provide cash to cover that gap.
This appraisal gap is the difference between the appraisal and the contract price. To cover the difference, the home buyer agrees to provide cash to cover that gap.
Home sellers love seeing this language in the contract because it makes the contract very competitive and the ultimate sale less likely to fall through. The home buyer will have to decide how much money they are willing to offer up as the “gap coverage.”
Adding an appraisal gap to your offer tells the seller that even if the property appraises for less than the purchase price in the contract, you are committing a preset dollar amount to make up the shortfall. This is important because it’s common to go over the asking price in a bidding war, and even though you say you will pay a certain amount, the bank will not lend you more than the appraised value of the home. This means you have to have the cash on hand to make up the difference.
Example of an Appraisal Gap
A home is listed at $50,000 and you decide to offer $510,000 with a $10,000 appraisal gap. That way, if the home only appraises for $500,000, the seller still gets $510,000. In this scenario, you would bring $10,000 cash to closing cover that gap in the contract price vs. the appraisal price. If the home appraises for $510,000 or above, you do not need to bring any gap coverage cash to closing.
Extra Cash Needed
Keep in mind that the cash to cover the appraisal gap is separate from the down payment. And as a result, it’s additional cash funds the home buyer needs to allot.
This can prove to be a bit of a gamble since the buyer won’t know for sure if they have to use the money until after the appraisal. There is a chance they could offer an appraisal gap and never have to use it. But, the buyer must have the money ready in the situation that the appraisal gap is enacted. Remember, there needs to be a discussion upfront between the buyer and real estate agent when bidding on a home – especially if you’re bidding over the asking price.
This can prove to be a bit of a gamble since the buyer won’t know for sure if they have to use the money until after the appraisal. There is a chance they could offer an appraisal gap and never have to use it.
Options When Writing an Offer
In Denver’s incredibly competitive seller’s market, home buyers must anticipate a multiple offer situation. As a result, an appraisal gap is a handy and almost necessary inclusion in a contract offer. Be sure to determine how much cash you have available to cover the difference between the appraisal and the contract price.
If you are making an offer on a home that’s been on the market for a few weeks, you may be able to get by without an appraisal gap. Make sure you discuss the scenarios with your broker to help you determine the best game plan.
Conclusion
Homebuyers must be ready to offer up many concessions when writing an offer. Be prepared for multiple bids on any home and work with an agent who has a proven track record on tactics and negotiations that might appeal to the home seller. Know your budget and bottom line, and don’t get yourself into a position of owning a home that you can’t afford. It may take several offers before finding your dream home.