When you decide to buy a house and sign a purchase agreement, your mortgage lender will require an appraisal to ensure the property’s value matches the agreed-upon price. If the appraisal comes in lower than expected, this creates an “appraisal gap,” which can lead to delays in closing, loss of earnest money, or even the cancellation of the transaction.
Appraisal Gaps and Their Impact on Closings
According to the National Association of Realtors, in 2024, approximately 5% of home closings were delayed due to appraisal discrepancies. Competitive bidding, unique property features, and inaccurate property details often contribute to these valuation differences. Fortunately, buyers and sellers can work with their real estate agents to address appraisal challenges using strategic approaches.
The Appraisal Process
Once the seller accepts your offer, your lender will arrange for an appraisal to assess the property’s market value. A licensed appraiser evaluates the home’s condition, upgrades, and unique features. They also measure the property to verify its square footage.
A key part of the appraisal process is a Comparative Market Analysis (CMA)—an evaluation of similar homes in the neighborhood, known as “comps.” The appraiser also considers current market conditions, trends in property values, and the supply and demand of similar homes.
After completing the appraisal, the lender receives a copy of the report and shares it with the buyer. The seller can also request a copy if needed. The appraisal fee is typically included in the buyer’s closing costs.
What Happens If the Appraisal Is Lower Than Expected?
If the appraised value is lower than the agreed purchase price, lenders will only approve a loan based on the home’s appraised value. This can create financial difficulties for both buyers and sellers. In a seller’s market, buyers may have to cover the difference, while in a buyer’s market, sellers may need to negotiate to close the deal.
Options for Buyers When an Appraisal Comes in Low
- Cover the Difference with Cash
- If you have additional funds available, you can increase your down payment to cover the appraisal gap and align with the lender’s loan approval.
- Negotiate with the Seller
- Work with your real estate agent to negotiate a lower purchase price. According to Ruthann Hewgley of Realty Pro Oregon, “Sellers are often willing to adjust the price if there are multiple offers and concerns about the appraisal value.”
- Challenge the Appraisal
- You and your real estate agent can request a review or a second opinion by presenting additional comparable home sales that support a higher valuation.
- Seek a Second Appraisal
- Some lenders allow a second appraisal at the buyer’s expense or may consider alternative financing options to achieve a better valuation.
If the contract includes an appraisal contingency, buyers can legally back out of the deal and potentially recover their earnest money deposit. However, without a contingency, backing out could result in forfeiting the deposit and possible legal consequences for breach of contract.
Options for Sellers Facing an Appraisal Gap
- Offer to Cover the Appraisal Gap
- Sellers can contribute funds to help bridge the difference and keep the sale moving forward.
- Split the Cost with the Buyer
- A shared approach, where both the buyer and seller contribute to covering the gap, can be a fair resolution.
- Accept the Lower Appraised Value
- Though this may mean selling for less than expected, it prevents relisting and facing similar appraisal challenges.
- Reassess the Purchase Agreement
- Sellers can adjust the sale terms, such as offering incentives or covering part of the buyer’s closing costs, to encourage a successful closing.
- List the Property Again
- If the deal falls through, sellers may choose to put the home back on the market and make improvements to increase its value.
How a Low Appraisal Affects Home Loans
Lenders use the Loan-to-Value (LTV) Ratio to assess risk, comparing the loan amount to the home’s appraised value. If the appraisal is lower than the purchase price, it may result in:
- Loan denial due to excessive risk
- A requirement for a higher down payment
- A higher interest rate
- The need for Private Mortgage Insurance (PMI), increasing monthly payments
Loan-Specific Considerations
- Conventional Loans: Appraisal contingencies are optional but recommended in the purchase agreement for added protection.
- FHA & VA Loans: These government-backed loans require appraisal contingencies, allowing buyers to exit the deal if the appraisal is too low. While sellers cannot directly cover the appraisal gap, they can assist with closing costs up to a certain percentage of the purchase price.
Is a Low Appraisal Always a Deal Breaker?
Not necessarily! While sellers may not favor a low appraisal, buyers can still proceed by covering the gap, negotiating with the seller, or securing alternative financing. However, if negotiations fail or funds are insufficient, walking away may be the best option. Having an experienced real estate agent can make all the difference in navigating these challenges efficiently.
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