An appraisal gap is an issue that can prevent a real estate transaction from closing. A professional appraiser may look at the property and decide, based on its condition and the recent sale price of other properties nearby, that it is not worth what the buyer offered to pay. They will then send their report to the lender, and the closing may not move forward as planned unless the buyer can secure additional financing.
A scenario involving an appraisal gap will often lead to a buyer canceling the transaction because they cannot obtain a mortgage for the full purchase price of the property. Unless the seller will compromise on the price, the transaction will fall apart. Occasionally, buyers who did not have the right contingencies in their offers will be at risk of losing their earnest money due to a low appraisal. Thankfully, there are ways that buyers can protect themselves against a scenario in which a transaction falls apart in the 11th hour due to financing issues caused by a low appraisal.
Wording contingencies very carefully
Although sellers prefer offers with fewer contingencies, they are still important for buyer protection. The inclusion of an appraisal or financing contingency, possibly both, is one of the most important protections for a buyer making an offer.
Sometimes, buyers hoping to remain competitive while protecting themselves with a contingency specify if they are willing to cover some of the difference. Some buyers, for example, might retain $10,000 in cash that could go toward covering the difference in a low appraisal scenario.
However, it will be of the utmost importance to word such clauses very carefully and to ensure that covering the appraisal gap will not leave the buyer with more debt than they can handle or fewer resources than they need when moving into a new home. Buyers must be careful to retain enough funds to cover the difference between their offer and what the lender will finance.
Tracking the market carefully
The best way to protect oneself from an appraisal gap is to avoid offering more for a property than it is technically worth. Many buyers need the support of not just a buyer’s agent but also an attorney to most effectively protect themselves and their resources when purchasing real property.
When prices have gone up significantly in recent years, as is currently the case, the risk for an appraisal gap is higher than it would be in regard to a more stable market. As a result, having the right protections in place can make all the difference for those buying in a competitive market.