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When negotiating a property purchase, it’s tough to know what a home is truly worth until it has been appraised. If the home’s value is less than the offer price, this can cause problems for both parties. For this reason, some purchase contracts will include an appraisal gap clause to assure the seller that the buyer will stand by their offer.
Below, we cover everything you need to know about the appraisal gap clause and how buyers can use it to their advantage.
The Appraisal Gap ClauseThe Appraisal Gap Clause
As you probably know, a home appraisal is an evaluation carried out by a lender during the mortgage application process to determine a property’s current market value. Lenders place a lot of importance on this process because it will tell them whether a property’s value is worth the loan amount. If the appraisal does come back as equal to or more than the loan amount, then all is well, and the loan will most likely be approved.
But if there’s a large gap between the appraised value and the loan amount, the lender is unlikely to approve the loan. Otherwise, they risk a loss if the property forecloses and they have to short sell it for less than the loan amount. If the buyer can’t cover the gap or renegotiate the purchasing price with the sellers, the deal will almost certainly fall through.
Include an appraisal gap clause in the contract rider to protect you against this. This commits the buyer to cover the appraisal gap or risk losing their deposit.
Why Would a Buyer Agree to an Appraisal Gap Clause?Why Would a Buyer Agree to an Appraisal Gap Clause?
At this point, you may wonder what on earth would make a buyer agree to such a clause. Well, for one thing, it makes your offer look stronger. Bidding wars are very common in NYC’s highly competitive real estate market. If buyers have their hearts set on a particular property, they may be willing to offer more than the home is worth. However, a seller may balk at an overpriced, financed offer since they know there will likely be appraisal issues.
But by including an appraisal gap clause, you are signaling to the seller that you’re aware your offer might be inflated and are willing to take that risk to secure the property. It puts the seller’s mind at ease about accepting your offer rather than a competing offer that they are less sure about.
What Can You Do When the Appraisal is Less than Your Offer?What Can You Do When the Appraisal is Less than Your Offer?
Even with an appraisal gap clause in the contract, you still have a few options for dealing with a low appraisal.
1. Pay the Difference1. Pay the Difference
The simplest solution is to pay the difference to close the deal with minimal fuss. Remember that this is a likely outcome, so you should have additional liquid funds available to cover this eventuality. You should not agree to an appraisal clause if you don’t have a large cash reserve to cover the appraisal gap. To provide better security, you can limit the appraisal gap. That way, you’ll have an exit strategy if the gap is too large to bridge.
2. Renegotiate the Offer Price2. Renegotiate the Offer Price
Provided you also have an appraisal contingency included in the contract, you should be able to renegotiate the offer price with the seller. If the appraisal gap is just a little above your limit, you may be able to get the seller to come down on the price to save the deal. However, this is risky if there are other offers on the sidelines.
Again, it bears repeating that the seller is only likely to renegotiate if they aren’t getting many other offers and are in a hurry to sell quickly. Any renegotiations should be handled entirely by your buyer’s agent.
3. Challenge the Appraisal3. Challenge the Appraisal
Licensed appraisal professionals carry out all home appraisals, and while they are very good at their jobs, they’re not above making mistakes from time to time. If you believe that the appraisal is not accurate, then you have the option to challenge it and request a second appraisal.
However, it’s entirely up to the lender whether they will agree to this request. You can’t simply challenge an appraisal because you don’t like the results; you need to have strong evidence that the appraiser was negligent or didn’t use appropriate comparable sales in their evaluation. To challenge an appraisal, you must do it in a written letter to your loan offer. Keep it short and sweet with plenty of evidence to support your dispute.
4. Get a Second Opinion4. Get a Second Opinion
If your lender doesn’t agree to a reappraisal, then you have the option to switch lenders. They’ll send out another appraiser who might give you a more favorable evaluation. However, switching lenders at this point in the deal will not be fast or easy. You’ll need to go through the entire mortgage application process again, and there’s no guarantee that the second appraiser will give you a result different from the first. Also, the seller isn’t likely to be happy about this delay and may push you to either cough up the difference or risk losing the deal to another buyer.
5. Walk Away5. Walk Away
If all else fails, you may have the option to walk away from the deal. An appraisal or financing contingency will allow you to do this. However, things get much more complicated when an appraisal gap clause is included in the contract. You’ll almost certainly lose your deposit, equating to tens of thousands of dollars in NYC. Make sure to consult your buyer’s agent and real estate attorney on this before you pull the plug.
Final ThoughtsFinal Thoughts
Before you make an offer, your buyer’s agent will perform a Comparative Market Analysis (CMA), so you can be confident of the home’s market value. Offering more than it’s worth could be enough to secure an accepted offer, but you will probably run into appraisal issues if you’re financing it.
An appraisal gap clause can be a helpful way to increase the strength of your offer while also appeasing any appraisal concerns from the seller. Make sure you know what you agree to and have the funds necessary to close the gap.