There are many moments in home buying that cause stress, but arguably the waiting period until you learn about the appraisal value of a home post-offer is chief on that list.
At that juncture, the buyer typically is in “love” with the home, the intricate negotiations are over, but now – just as the buyer seems to glimpse that light at the end of the tunnel – in comes a third-party appraiser whose assessment could determine whether the buyer can actually afford the home.
Why is that?
How does the appraisal process work, and what can buyers do to protect themselves?
An appraisal can be complex and detailed but is – at its root – based on two assessment pillars: comparable sales (comps) or this particular home’s condition.
For comparable sales (comps), the appraiser will look at similar homes (square footage, features, sub-neighborhoods, school access, etc.) that sold in the neighborhood recently (usually six months in a reasonably fluid market).
For the home’s condition, the appraiser will measure how “sound” the home is. They’ll assess safety and sanitation, they’ll make sure the features that are supposed to work do, and they’ll ensure that there aren’t any major issues that could render the home unlivable.
An appraisal sounds daunting, but it can actually function as a buyer’s best friend – as long as the buyer and seller negotiate an “appraisal” contingency into the contract.
That means if the appraisal comes in lower than the offered amount for the home, buyers can pull out of the transaction and retrieve their earnest-money deposits, or renegotiate the sale price with the sellers.
For instance, if the agreed-upon offer is $400,000 for the home, but the appraisal comes in at $380,000, the buyers and sellers may renegotiate and split the difference by reducing the price to $390,000, with both parties bearing half the burden. Of course, if the appraisal comes in substantially lower – say, $340,000 – the buyer may decide to walk given the appraisal gap.
In overheated markets, sellers have the advantage and are often able to win a waiver of the appraisal contingency. This means that the sale must go through regardless of the appraisal figure. Of course, the buyers can still walk away, but they would lose their earnest-money deposit.
In sellers’ markets like Silicon Valley, Manhattan, and the suburbs around our nation’s capital, appraisal-contingency waivers are all too common. Let’s look at the $340,000 appraisal example against the $400,000 negotiated price. A bank will only lend against the appraised value -- $340,000 – so, without an appraisal-contingency waiver, the buyers would have to come up with the difference of $60,000 themselves.
In many cases, home buyers thread the needle when it comes to affordability – if they had an additional $60,000 sitting around under the proverbial mattress, they likely would have bid on a more expensive home.
So, what’s the buyer’s recourse in this tough appraisal-gap situation?
First - you can beg and borrow, but don’t steal. If there’s ever a moment to borrow funds from relatives, this may be it. If you do borrow from family or friends, though, make sure the gift is accompanied by a “gift letter.” This helps convince lenders that the funds truly are a gift, and not a loan disguised as a gift. When large cash influxes find their way into a buyer’s accounts right before a mortgage loan, banks get (understandably) suspicious. Gift letters tend to smooth the process.
A buyer may also look into accessing other funds to help bridge the appraisal gap – perhaps there are palatable ways to borrow from 401k plans or other savings instruments. A financial adviser can be a key resource here as the buyer evaluates the most cost-effective way to come up with the $60,000.
There’s a strategic way to deal with an appraisal gap as well. You could mount a case to dispute the appraisal. A dispute is not the easiest path forward, but it has rescued many stressed buyers.
You'll have to prove at least one of several factors to win a dispute:
- the comps the appraiser used weren’t market-appropriate, or weren’t recent enough to reflect an uptick in nearby home prices;
- the appraiser simply missed key features or improvements to the home;
- there were clerical errors in the report; or
- the appraiser simply “phoned it in” and only did an exterior assessment of the home. Given the fact that many home appraisers have been in the industry for decades, they are typically too experienced to make these errors or omissions.
Buyers tend to have the most success with proving the appraiser didn’t take the most relevant recent comps into account, but it’s still an uphill climb to win a dispute.
In those cases, your best option may be to walk away from the sale. Again, if the contract has an appraisal contingency, walking away is painless: The buyer gets the earnest-money deposit back.
But if we’re talking about overheated markets where the buyer has to negotiate away the right to the contingency’s protections via a waiver - the earnest-money deposit is typically around two percent (or $8,000 for this $400,000 offer example). Walking away from that sum may hurts, but if the appraisal gap is substantial, “eating” the earnest-money deposit may be the safest and most prudent option.
Bottom line:
You should do everything in your power to insert an appraisal contingency into a contract. Without that safety valve, waiting for the appraisal to come in would still carry tremendous stress.
