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A Low Appraisal in a Hot Market Can Be a Deal-killer. Here’s How To Salvage Your Purchase

A Low Appraisal in a Hot Market Can Be a Deal-killer. Here’s How To Salvage Your Purchase
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Home.com Contributor

Before you buy a home, there are several steps your mortgage lender will require before they will approve your loan. One of those most nerve-wracking for homebuyers is the appraisal.

A home appraisal is conducted by an expert appraiser who will determine the value of the property based on their inspection of the home, recent sales of comparable properties, current market trends, the home’s location, and other factors.

The reason homebuyers sometimes dread the appraisal is that a low appraisal in a hot market can be a deal-killer, unless they’re willing (and able) to cover the difference between the appraised value of the home and the sale price themselves.

But a low appraisal isn’t necessarily the end of the road. It’s possible to make the transaction work if you and the seller work together — and you’re both willing to compromise.

What's in this Article?

Why is the appraisal value so important to your lender?
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Why would an appraisal come back low?
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How to handle a low appraisal in a hot market
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FAQs
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Work with a team you trust
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Why is the appraisal value so important to your lender?

Lenders typically require home appraisals for a simple reason: They want to protect their financial interests.

“An appraisal is an important tool in a real estate transaction to ensure the property is being sold for what the property is worth,” said Brian Coutu, a Ft. Lauderdale-based loan officer with Fairway Independent Mortgage Corporation (Fairway owns Home.com). “When getting a mortgage it is typically required for the buyer to obtain an appraisal so that we can ensure we have an appropriate loan to value. As a lender, we cannot lend more than the lesser of the sales price or the appraised value.”

“Ultimately, lenders need to ensure they are making a sound investment when lending a large sum of money. They have quite a bit of skin in the game,” said Allison Orenstein, a real estate attorney based in Newton, Mass. “If they are lending $400,000 on a property that is worth less than that, and they ultimately need to foreclose on that home, they will be shorted on their investment.”

The appraisal confirms that the house is worth the amount of money the lender is approving you for. They will not give loans for more than a home’s appraised value.

“An appraisal is an important tool in a real estate transaction to ensure the property is being sold for what the property is worth.”

Brian Coutu, Fairway Loan Officer

“For example, using the previous scenario in which you want to borrow $400,000, let’s say the asking price is $500,000, for which you put 20% down. The lender will need to confirm that the property is indeed worth $500,000 in order to lend you the $400,000,” Orenstein continued. “But if the appraisal comes in at $450,000, the lender will only be able to lend 80% of the value, which is $360,000 – creating a $40,000 deficit between the mortgage amount and the purchase price.”

If there is a gap between the market value of the home and the sale price, you will need to decide whether you’ll:

  • Bridge the gap using your own funds or gift funds (if eligible for your loan)
  • Request a reconsideration of value on the appraisal through your lender
  • Walk away from the sale
  • Negotiate with the seller to see if they will lower the price to the appraised value.

Lenders aren’t the only ones who benefit from an appraisal, however. Appraisals are also in the buyer’s and seller’s interest as well.

“To a seller, it could be good to get an appraisal completed prior to listing their property to ensure that they are not leaving any money on the table when coming up with a sales price. Also, if the seller needs to sell the home quickly it is equally important to know the value of the home so that they don’t list the property for more than it is worth,” Coutu explained. “For a buyer, it is crucial to get a valuation on the property for the opposite reason. They want to make sure they are not overpaying for a property.”

Related: FHFA Expands Eligibility for Refinance Programs, Restores Desktop Appraisals

Why would an appraisal come back low?

There are several reasons why the appraised value may come in lower than the list price.

Chief among them is strong demand.

In hot markets, a home can be offered at a high price compared to previous sales in the area. Good real estate agents know what price a house will command at any given time, even if no others around it have achieved that price range yet. Or, in a bidding war, a home can get bid up beyond any recent sales of similar homes.

That’s a problem, because an appraisal, at its core, is simply a comparison of one house to a group of others. The price another buyer paid for a similar home is the only true measuring stick for what another home is worth.

“An appraisal may come back surprisingly low when there are no recent or reasonably comparable sales in the same price range in that area, even in cases where there were multiple offers above comparable sales,” said David North, broker and owner of Realtrua in Redmond, Wash.

“Different appraisers don’t necessarily see each detail the same way. Despite restraints against subjective biases, every property has nuances that can be valued differently by one appraiser versus another.”

David North, owner of Realtrua

In the current housing market, the demand for homes has been so great that bidding wars drove up the list prices in many areas. But an appraiser isn’t going to assign a value to a home unless others like it have sold for a similar amount.

Also, a home doesn’t get much additional value if it’s overbuilt for the area. So even if a home is in pristine condition and recently remodeled, it’s probably not going to be appraised at $500,000 if all of the other properties in the neighborhoods have sold for around $250,000. Hence the old adage, “buy the worst house on the block.”

The appraisal process isn’t necessarily foolproof or entirely objective, either.

“Different appraisers don’t necessarily see each detail the same way,” North said. “Despite restraints against subjective biases, every property has nuances that can be valued differently by one appraiser versus another.”

Britta Traub, a real estate investor in Charlotte, N.C., noted that some appraisals are done via computer, called “drive-by appraisals,” which can skew the value of the home lower. If the appraiser doesn’t inspect the home themselves, they may miss value-adding features if they are working off outdated documents on the property.

“Another reason why an appraisal could come back low is due to the condition of the house. Just because the market is taking off in that area doesn’t mean that home’s value will automatically increase like the rest of the neighbors,” Traub said.

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How to handle a low appraisal in a hot market

Usually, when an appraisal value comes in lower than anticipated, the seller and buyer should look first to their real estate contract (purchase agreement) for guidance.

“Purchase and sale agreements should provide terms for recourse for both the buyer and the seller in the event of a low appraisal,” North said. “Generally, unless agreed otherwise, the seller cannot be forced to sell for a lower price and the buyer cannot be forced to pay more than they agreed to pay. The parties may be able to reach a compromise or they may need to terminate the transaction if they cannot work things out.”

Five strategies to handle a low appraisal

  1. The buyer and seller negotiate for a reduced price and/or needed repairs or upgrades that would improve the home’s value
  2. The buyer asks the lender for a second opinion by requesting a reconsideration of value if the agent can provide additional supporting comps (homes) that the appraiser did not consider in their original appraisal that help support the purchase price
  3. The buyer brings extra cash to the deal “to bridge the gap between the appraised value and the purchase price, trusting that the highly-competitive market, rather than the appraiser, has accurately determined the purchase price,” explained Aimee Stern, director of the Estates Division and broker associate with The Agency in Los Angeles
  4. The buyer accepts mortgage insurance based on a higher loan-to-value ratio
  5. The buyer cancels the transaction to avoid overpaying for a property deemed of lesser value
5 strategies to handle low appraisal in hot market

Strategy #1: Negotiating a reduced price or home improvements

To ensure the sale moves ahead, you and the seller can come to a mutual agreement to lower the home’s purchase price to the appraised value.

“From a practical standpoint, it may make more sense for the seller to reduce the price now versus putting the property back on the market and starting all over again with a new buyer – only to have the home appraised low a second time around,” Orenstein said.

However, because the seller will lose money with this approach, buyers shouldn’t expect that the seller will agree to this option, particularly in a hot real estate market where homes are going for record-high prices.

If you’re in an area where bidding wars are common, sellers may be less inclined to lower the sale price if they’re confident another buyer will have the cash to pay the appraisal gap.

An alternative to lowering the sale price is that you can negotiate to make necessary repairs and home improvements that will increase the home’s value enough to satisfy the appraiser. The cost of these improvements can be paid for by the seller or buyer, or they can share the costs.

Strategy #2: Get a second opinion

You can push for a second appraisal, or a reconsideration of value, if you don’t agree with the verdict of the first.

“The buyer may choose to challenge the appraisal, which essentially signals to the appraiser that they didn’t do their job correctly. But this can be met with resistance and mixed results,” cautioned Orenstein.

Dan Belcher, a real estate broker and founder and CEO of Mortgage Relief, said sellers can help their cause by making the case that the home merits a higher value.

“Sellers can gather real estate comps and collect evidence to back up their claim that their home is worth what they are asking for it,” he said.

Coutu noted that the best way to dispute an appraisal is to provide additional comparable properties that the appraiser might have missed.

“This, along with a well-thought out explanation on why the new comp is better than the comps used on the report, is always a best practice,” he said.

He added that the buyer and seller can also dispute property details in an appraisal report, including  the square footage, number of bedrooms and bathrooms listed, the property condition, and other relevant sections that may raise the value or change the opinion of the appraiser.

“I think the most important thing to do when disputing an appraisal is to be as detailed as possible. Don’t just send an opinion. Lead your dispute with facts and data.”

Brian Coutu, Fairway Loan Officer

Belcher added that sellers can also opt to pay for their own independent appraisal, the results of which can be submitted to the buyer and the buyer’s lender, if the new appraisal shows a more favorable valuation.

However, Coutu cautioned that you can’t simply order a new appraisal without cause.

“If the value does not change after the appraisal dispute process, we would need to try to find a reason or material flaw to throw the appraisal away and order a new one,” he said. “This can be very difficult. One of the biggest misconceptions that I hear from buyers, sellers, and Realtors is that they think we can just order a new appraisal. We need to have a reason on why we need to order a new one, more than just the opinion that they feel that this is a ‘bad appraisal.’”

Strategy #3: Bring extra cash to the deal

If you have your heart set on a particular house, regardless of the appraised value, you can save the deal by paying the difference between the appraised value and the offer price out of pocket.

“Buyers can apply for other loans or personally finance the cash difference using their savings,” Belcher said. “But it’s important to consider the possibility that you will be overpaying for the property.”

“If you believe that the area will continue to grow and your repairs will make the house worth more, you may want to take the chance and make up the difference in cash.”

Britta Traub, real estate investor

If you decide to sell the home, you may not get as much as you paid for it, and you’ll lose money long-term.

Traub agreed that this option should be evaluated carefully.

“You have to determine if the house is worth the extra money out-of-pocket or not. Take into consideration any repairs that may need to be made as well as the location,” she said. “If you believe that the area will continue to grow and your repairs will make the house worth more, you may want to take the chance and make up the difference in cash.”

 

Original plan Negotiate price Get a second opinion Bring in approved funds or gift funds Accept mortgage insurance
Price$300,000$290,000*$300,000$300,000$300,000
Appraised value$300,000$275,000$290,000**$275,000$275,000
Loan amount$240,000$220,000$232,000$220,000$240,000
Loan-to-value80%80%80%80%87%***
Closing costs$5,000$5,000$5,500 (extra appraisal cost)$5,000$5,000
Cash to close$65,000$75,000$73,500$85,000$65,000
*There’s no guarantee that the seller will negotiate a lower price
**You may not get a higher value by requesting a second opinion (ordering a new appraisal)
***Loan-to-value is based on appraised value, not purchase price. LTVs over 80% require mortgage insurance, which is an additional monthly fee.

Strategy #4: Accept mortgage insurance

If you don’t have additional cash to cover the appraisal shortage, you could potentially accept mortgage insurance instead.

Loans over 80% of the value require mortgage insurance. And your loan-to-value ratio could jump above this threshold if the appraisal comes in low.

For example, a $240,000 loan on a home worth $300,000 has an LTV of 80%. But if the home is only worth $275,000, the LTV would be 87% and the loan would require mortgage insurance.

Fortunately, loans over 80% are allowed. You would have to pay an extra amount every month – perhaps around $100-$300 based on your credit profile and loan characteristics – but it saves you having to come in with extra cash.

Strategy #5: Find another house

An appraisal that determines that the home you want to buy is worth less than the purchase price is a red flag, signaling that this could be a bad deal.

“If there is an appraisal or mortgage contingency in your purchase contract, and the property appraises below the purchase price, in certain cases the buyer can terminate the transaction and get their deposit back. But if there is no such contingency in place, you will need to decide whether or not you can afford to make up the difference in cash and if doing so is a good investment,” Orenstein said.

In the current market, you may feel pressure to make an offer without any contingencies in the purchase agreement. But that may hurt your leverage if the appraisal value comes in lower than desired.

“Consult closely with your real estate agent and attorney to evaluate the pros and cons of waiving protection in the event of a low appraisal,” Orenstein added.

Low appraisal in a hot market FAQs

What if an appraisal comes in low?

If a real estate appraiser determines that the home you want to buy is worth less than the purchase price, your mortgage lender may deny your loan or only agree to finance up to the appraised value.

In this scenario, you can negotiate with the seller to lower the purchase price or make the needed home improvements to get a higher valuation. You can also challenge the appraisal with a reconsideration of value or order a second appraisal, as another appraiser may value the home at a higher price.

Finally, you can make up the difference in cash out of pocket from your savings, or walk away from the deal entirely and look for another home.

Is a low appraisal good for the seller?

No. A low appraisal can jeopardize the transaction because the buyer may not receive the mortgage financing they need to purchase the home or be able to pay out-of-pocket the difference between the appraised value and the purchase price. It may be in the seller’s best interest to lower their asking price instead of risking that the deal will collapse, which would require them to put the property back on the market and seek a new buyer, whose appraisal may also come in low.

Can a seller back out if the appraisal is low?

A seller may be allowed to back out of a transaction if the appraisal comes in low. This may be best if you are a seller who wants to avoid making compromises and improve your chances of getting the highest dollar for your home. For guidance, review your real estate purchase agreement and consult your real estate agent and attorney about your options.

Are appraisals coming in lower than usual in 2021?

Data from CoreLogic suggests a recent trend toward lower appraisals than normal. In January 2020, 7% of purchase transactions across the country had a contract price higher than the appraisal. However, by May 2021, this rate had risen to 19% of purchase transactions.

Work with a team you trust

Getting a low appraisal in a hot market is frustrating and disappointing. That’s why it’s key to work with a real estate agent and lender you trust. They can advise you on your options and whether it’s wise to pursue a second appraisal.

And if you end up having to walk away from the deal, your agent can help you find another property fast and your lender can help you keep your loan file up to date. That way, you can move swiftly when you’re ready to make an offer again.


Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.

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