If you’re searching for drama, don’t limit
yourself to Netflix. Instead, tune in to the real estate market, where the
competition among buyers has never been fiercer. And with homes selling for
record highs,1 the appraisal process—historically a standard part of
a home purchase—is receiving more attention than ever.
That’s because some sellers are finding out
the hard way that a strong offer can fizzle quickly when an appraisal comes in
below the contract price. Traditionally, the sale of a home is contingent on a
satisfactory valuation. But in a rapidly appreciating market, it can be
difficult for appraisals to keep pace with rising prices.
Thus, many sellers in today’s market favor
buyers who are willing to guarantee their full offer price—even if the property
appraises for less. For the buyer, that could require a financial leap of faith
that the home is a solid investment. It also means they may need to come up
with additional cash at closing to cover the gap.
Whether you’re a buyer or a seller, it’s never
been more important to understand the appraisal process and how it can be
impacted by a quickly appreciating and highly competitive housing market. It’s
also crucial to work with a skilled real estate agent who can guide you to a
successful closing without overpaying (if you’re a buyer) or overcompensating
(if you’re a seller). Find out how appraisals work—and in some cases, don’t
work—in today’s unique real estate environment.
An appraisal is an objective assessment of a
property’s market value performed by an independent authorized appraiser.
Mortgage lenders require an appraisal to lower their risk of loss in the event
a buyer defaults on their loan. It provides assurance that the home’s value
meets or exceeds the amount being lent for its purchase.
In most cases, a licensed appraiser will
analyze the property’s condition and review the value of comparable properties
that have recently sold. Mortgage borrowers are usually expected to
pay the cost of an appraisal. These fees are often due upfront and
Appraisal requirements can vary by lender and
loan type, and in today’s market in-person appraisal waivers have become much
more common. Analysis of the property, the local market, and the buyer’s
qualifications will determine whether the appraisal will be waived. Not all
properties or buyers will qualify, and not all mortgage lenders will utilize
this system.3 If you’re applying for a mortgage, be sure to ask your
lender about their specific terms.
If you’re a cash buyer, you may choose—but are
not obligated—to order an appraisal.
IN A RAPIDLY SHIFTING MARKET
An appraisal contingency is a standard
inclusion in a home purchase offer. It enables the buyer to make the closing of
the transaction dependent on a satisfactory appraisal wherein the value of the
property is at or near the purchase price. This helps to reassure the buyer
(and their lender) that they are paying fair market value for the home and
allows them to cancel the contract if the appraisal is lower than expected.
Low appraisals are not common, but they are
more likely to happen in a rapidly appreciating market, like the one we’re
experiencing now.4 That’s because appraisers must use comparable sales
(commonly referred to as comps) to determine a property’s value. These could
include homes that went under contract weeks or even months ago. With home
prices rising so quickly,5 today’s comps may be lagging behind the
market’s current reality. Thus, the appraiser could be basing their assessment
on stale data, resulting in a low valuation.
BUYERS AND SELLERS IMPACTED BY A LOW APPRAISAL?
When a property appraises for less than the
contract price, you end up with an appraisal gap. In a more balanced market,
that could be cause for a renegotiation. In today’s market, however, sellers
often hold the upper hand.
That’s why some buyers are using the potential
for an appraisal gap as a way to strengthen their bids. They’re proposing to
take on some or all of the risk of a low appraisal by adding gap coverage or a
contingency waiver to their offer.
Appraisal Gap Coverage
Buyers with some extra cash on hand may opt to add an
appraisal gap coverage clause to their offer. It provides an added
level of reassurance to the sellers that, in the event of a low appraisal, the
buyer is willing and able to cover the gap up to a certain amount.6
For example, let’s say a home is listed for
$200,000 and the buyers offer $220,000 with $10,000 in appraisal gap coverage.
Now, let’s say the property appraises for $205,000. The new purchase price
would be $215,000. The buyers would be responsible for paying $10,000 of that
in cash directly to the seller because, in most cases, mortgage companies won’t
include appraisal gap coverage in a home loan.6
Waiving The Appraisal Contingency
Some buyers with a higher risk tolerance—and
the financial means—may be willing to waive the appraisal contingency
altogether. However, this strategy isn’t for everyone and must be considered on
a case-by-case basis.
It’s important to remember that waiving an
appraisal contingency can leave a buyer vulnerable if the appraisal comes back
much lower than the contract price. Without an appraisal contingency, a buyer
will be obligated to cover the difference or be forced to walk away from the
transaction and relinquish their earnest money deposit to the sellers.7
It’s vital that both buyers and sellers
understand the benefits and risks involved with these and other competitive
tactics that are becoming more commonplace in today’s market. We can help you
chart the best course of action given your individual circumstances.
WAIVE YOUR RIGHT TO THE BEST REPRESENTATION
There’s never been a market quite like this
one before. That’s why you need a master negotiator on your side who has the
skills, instincts, and experience to get the deal done...no matter what
surprises may pop up along the way. If you’re a buyer, we can help you compete
in this unprecedented market—without getting steamrolled. And if you’re a
seller, we know how to get top dollar for your home while minimizing hassle and
stress. Contact us today to schedule a complimentary consultation.
Wall Street Journal -
US News & World Report - https://realestate.usnews.com/real-estate/articles/what-is-a-home-appraisal-and-who-pays-for-it
Rocket Mortgage –
S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index - https://www.spglobal.com/spdji/en/indices/indicators/sp-corelogic-case-shiller-20-city-composite-home-price-nsa-index/#overview
Bigger Pockets -
Washington Post -