An appraisal is an estimate of a property’s fair market value as determined by an unbiased third-party — a licensed appraiser. It’s an important part of any home sale transaction, as it confirms for a lender that the property is adequate collateral for the mortgage.
But the appraisal can be lower than the purchase price, causing problems for buyers and sellers hoping to close. When this happens, buyers and sellers typically have three options: The buyer can make up the difference in cash, the seller can lower their listing price, or they can choose to dispute the appraisal.
An appraisal that’s higher than the purchase price can happen for a number of reasons. Home values may go up after a house is listed, or sellers may price their home under market value to compete in a buyer’s market.
If a house is appraised for more than the offer price, the buyer has essentially agreed to pay the seller less than the home's market value — and that's the seller's concern, not the buyer's. A high appraisal won’t impact your financing if you're buying a house; in fact you can see it as a positive since you'll have built some extra equity in the home right off the bat since the house is worth more than the loan amount.
A low appraisal means that the fair market value of the home is less than what the buyer has offered to pay for it. While this may seem insignificant, a low appraisal can make it hard or impossible for a buyer to secure a mortgage. It’s a daunting prospect, but there are options for both buyers and sellers who find themself in this situation.
The lender won’t necessarily give the prospective buyer a loan — they’ll only issue a mortgage for an amount that is equal to the loan-to-value (LTV) ratio agreed to in the proposed contract.
Your lender will use your appraisal to calculate your LTV. The lower your LTV is, the less risky you look to lenders. Ideally, you want to have an LTV of 80% or less. Having a good LTV will not only help you secure a loan, but better rates as well. If you have an LTV of more than 80%, you’ll need to pay private mortgage insurance, which helps mitigate risk for lenders if you default on your loan.
Let’s say a home appraises for $800,000, but the buyer agreed to pay the seller $875,000. If the seller refuses to negotiate down the sales price of the home, the buyer would only be able to get a mortgage for $800,000 and they would owe the seller $75,000 in cash (alongside their down payment) upfront in order to purchase the home.
Appraisals reflect the market at the time they are conducted, not at the time the home was listed. They fluctuate as a reflection of the changing times.
Low appraisals happen for a number of reasons but the most common is a shifting market. The housing market has been in an extreme seller's market from mid 2020 to April 2022, and as the market has slowed down, housing prices have fluctuated — some areas have even entered a market correction. In the most affected areas, home prices have dipped as much as 10%.
While there’s little you can do to control the market, there are some steps you can take to prepare for your appraisal:
If things don't go according to plan and the buyer makes an offer that surpasses the home's appraisal value, they have a few options for how they can proceed.
An appraisal isn't set in stone and it's possible to dispute the original assessment. If the first appraiser doesn't reconsider their initial valuation, the buyer can book an appraisal with a new appraiser to get a second opinion.
The buyer has the option to go back to the seller and negotiate a lower sales price that fits within the appraisal so the buyer can secure a mortgage loan. If the seller refuses to drop the sales price, the buyer can walk away from the sale, as long as they have an appraisal contingency clause in their purchase agreement.
If the buyer chooses to walk away from the sale, that isn’t necessarily game over. They can keep an eye on the home. It may be hard for the seller to find a new buyer who wants to make an offer on the home, and if they can’t find one, the original buyer may be able to come back and see if the seller will negotiate with them again. Awkward? A bit, but doable.
Appraisals aren’t an exact science. The appraiser, the current real estate climate, and a variety of other factors impact appraisal values. If the homeowner or buyer has concerns that the appraisal value is too low, they can dispute the appraisal or get a second appraisal.
The buyer may need to pay for a second appraisal, unless the seller or buyer does this research and presents it to the lender. If the lender thinks a second appraisal is necessary, they will pay for it.
Suppose none of those above tips help get the appraisal back on track. In that case, the buyer can choose to walk away (if they have an appraisal contingency in their contract) or make up the difference between the appraisal amount and the home's sales price in cash.
A seller with a good real estate agent is likely to price their home fairly and as long as the buyer doesn’t end up in an intense bidding war that raises the price too high, the appraisal value should come back in line with the sales price.
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