Much like the home inspection, the appraisal is often one of the final hurdles in a real estate transaction. But what exactly is an appraisal, and what happens if the home does not appraise for the agreed-upon sales price?
What Is a Home Appraisal?
A home appraisal is an independent opinion of a property’s market value completed by a licensed or certified appraiser. When a buyer is financing a home, the lender typically orders the appraisal through an independent process.
The appraiser examines the property and considers factors such as its location, condition, size, features and recent sales of comparable homes in the area. The resulting appraisal report helps the lender determine whether the property provides adequate collateral for the amount being financed.
In simple terms, the lender wants to make sure it is not lending more money than the home is reasonably worth.
Is an Appraisal the Same as a Home Inspection?
No. Although both usually happen during the purchase process, they serve different purposes.
A home inspection evaluates the property’s condition and may identify needed repairs, safety concerns or other potential problems. An appraisal primarily determines the property’s market value for the lender.
An appraisal should never be treated as a replacement for a professional home inspection.
What Is an Appraisal Contingency?
An appraisal contingency is language in the sales contract that may give the buyer certain options if the home’s appraised value is lower than the contract price. The exact rights and deadlines depend on the contract, the financing and the specific circumstances of the transaction.
Most appraisals come in at or slightly above the agreed-upon sales price. Sometimes, however, the appraised value is lower. The difference between the contract price and appraised value is commonly called an appraisal gap.
For example, imagine that a buyer agrees to purchase a home for $400,000, but the appraisal values it at $390,000. That creates a $10,000 appraisal gap.
The lender will generally base the loan on the lower appraised value—not simply the price written in the contract. That does not automatically end the transaction, but the buyer and seller will need to determine how to address the difference.
What Happens When an Appraisal Comes in Low?
Depending on the contract and loan program, the available options may include:
The seller lowers the sales price
The seller may agree to reduce the contract price to match the appraised value. This resolves the gap without requiring the buyer to bring additional money.
The buyer pays the difference
If the buyer has sufficient funds, they may choose to pay the appraisal gap in cash. That amount is generally in addition to the buyer’s down payment and closing costs.
The buyer and seller meet in the middle
The seller may agree to lower the price by a portion of the difference while the buyer brings additional cash to cover the rest. This compromise can allow the transaction to continue without placing the entire burden on either party.
The seller holds firm
The seller may decide not to reduce the contract price. If the buyer cannot or does not want to cover the difference, the buyer may have the right to terminate—but that depends on the language and deadlines contained in the contract.
There may also be circumstances in which the appraisal can be reviewed or reconsidered if relevant information or comparable sales were overlooked. A request for reconsideration does not guarantee that the appraised value will change.
Why Appraisal Contingencies Matter
During the highly competitive real estate market of the COVID era, some buyers waived appraisal protections or agreed in advance to cover a specific appraisal gap to make their offers more attractive. That could strengthen an offer, but it also created additional financial risk for the buyer.
Appraisal issues do not arise in every transaction. When they do, however, the wording of the contract matters. Deadlines, available cash, financing requirements and the parties’ willingness to negotiate can all influence the outcome.
This is where having an experienced real estate and lending team can make a major difference. Your professionals can help you understand the available options, communicate with everyone involved and determine the best path forward for your particular transaction.
Every transaction is different. Before agreeing to waive an appraisal contingency or cover a potential appraisal gap, make sure you understand exactly what you are committing to—and how much additional cash you could be required to bring.