Appraisal Gap Explained
Jan 23, 2022
Definition of an appraisal: A real estate appraisal is an unbiased professional opinion of a home's value.The purpose of an appraisal is to help the lender/bank to determine the fair market value of a property to make sure the bank isn't lending on an overpriced property. Sometimes the lender will waive the appraisal for a low risk applicant especially if it's a primary residence with a large down payment amount but an appraisal is required for most traditional loan applicants. If the property appraises for lower than the sale price, then the bank will only lend based on the appraised value to minimize their risk so the buyer and seller must then negotiate on who covers the "gap".
Appraisal Gap refers to the difference ("gap") between the Appraised value and the Sale Price. In a highly competitive market where there are multiple offers, oftentimes signficantly higher than the asking price, the seller may be hesitant to accept such a high offer and worry that the property won't appraise for that high. In fact, the seller may accept a Cash offer or one with a higher down payment (e.g. Conventional loan at more than 25% down) even if those offers are not the highest. For a buyer trying to purchase a home with a low % down, offering an "appraisal gap" clause can be a very useful tool to compete with those Cash buyers.
An appraisal gap clause basically says that, "I am willing to put in extra money in addition to the down payment if the property does not appraise for the full sale price. For example, if the Sale price is $500k and it only appraises for $490k, then I'm willing to bring in the extra $10k so the seller still gets to sell the house at $500k"
Below is a flowchart that outlines the possible scenarios with an appraisal gap.
Scenario #1 with $10k appraisal gap: If the appraised value is $485k, the worst case scenario for the seller is to reduce the price to $485k, $15k below what the seller agreed to initially
Scenario #2 without the appraisal gap: If the appraised value is $485k, worst case scenario for the seller is to reduce the price to $495k, only $5k below what the seller agreed to initially.
As you can see, an offer with an appraisal gap is a stronger offer than one without because it gives the seller the comfort of knowing that the buyer is willing to come in with extra money if needed.
For more strategies on submitting offers in a highly competitive market, see the guide How to Win Offers.