What Is an Appraisal Gap Clause?
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Homebuying involves a dizzying array of numbers, from loan-to-value ratios (LTVs) and interest rates to down payments and closing costs. However, the two that matter most are the agreed-upon purchase price and the home's appraised value. When these figures don't align, there's an appraisal gap, which can complicate the sale process.ย
Here's what you need to know about appraisal gap clauses, including what they are, how they work, and your options for completing the purchase.ย
An appraisal gap occurs when the agreed-upon purchase price is higher than the appraised value of a home. Appraisal gaps are common in hot real estate markets where conditions change rapidly and bidding wars drive up prices. While an appraisal gap can disrupt the real estate sale process, it won't necessarily derail it. Still, you'll need to renegotiate with the seller, pay the difference, or successfully dispute the appraisal to get the home buying process back on track.ย
Among other details, a real estate purchase and sale agreement (PSA) specifies a purchase price: the amount that the buyer and seller agree the home is worth. If you're financing the purchase with a mortgage, your lender will require an appraisal to confirm that the price makes sense (and the property is a good investment). The appraisal determines the home's value based on what similar homes in the area have sold for recently.ย
If you have an appraisal gap there are a few options:
Let's say you want to buy a home with an asking price of $400,000. Your real estate agent submits an offer on your behalf for the full amount, and the seller accepts. However, your lender's appraiser says the home is worth just $380,000โmeaning there's a $20,000 appraisal gap.ย
The seller may not accept less than you offered, and your lender won't lend more than the home is worth. What happens next depends on whether your PSA includes an appraisal gap coverage, appraisal gap clause, or appraisal contingency.
Appraisal gap coverage vs. appraisal contingencyย
PSAs often include language to specify what happens if there's an appraisal gap, including appraisal gap coverage, an appraisal gap clause, and an appraisal contingency. While they sound similar, they're different. Here's a quick rundown:
No buyer wants to overpay for a house, but itโs sometimes necessary in a fast-moving seller's market. An appraisal gap clause makes your offer more attractive because it assures the seller that the sale can progress even with a low appraisal.ย
This can be especially important in hot real estate markets where bidding wars drive up prices. Be sure the wording in the appraisal gap clause reflects how much you're willing to pay above the appraised value or if (and how) you and the seller plan to split the difference.ย
An appraisal contingency gives you the right to end the contract and get your earnest money back if the appraisal is lower than the purchase price. Waiving the appraisal contingency can strengthen your offer in a competitive market. However, you'll forfeit your earnest money if the appraisal is low and you're unwilling or unable to pay the difference.ย
An appraisal gap clause binds the buyer to purchase the home even if the appraisal is lower than the agreed-upon purchase price. If the buyer backs out, they forfeit their earnest money deposit, and the seller could sue for breach of contract (though this is rare).ย
In a competitive market, it's easy to get caught up in a bidding war. However, before you agree to pay over the appraised value for a home, pause and consider the following:
If you really love the home and can comfortably afford the added costs, paying over the appraised value might be worth it to get into the home of your dreams.
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