When you buy a home, the lender will require an appraisal. It sounds scary and like it could stop you from getting the loan you need or the home you want. While an appraisal can be a stumbling block when you’re trying to buy a home, it’s there to protect you and the lender. Understanding the appraisal, how it works, and what your options are if the appraisal doesn’t come in high enough is important.

What Is an Appraisal?

An appraisal is a report written by a professional appraiser that determines a home’s fair market value. Lenders require it to determine how much collateral is in the home and if the loan is a good risk.

Appraisals are necessary so banks know the home is worth enough for them to sell it should you not make your payments. The bank needs to make their money back, so they won’t approve a mortgage application if the home isn’t worth at least as much as the sales price.

How Do Appraisals Work?

After you find a home and sign the sales contract, the lender orders the appraisal. The professional appraiser schedules an appointment with the seller to come see the house.

Appraisers must see the inside and outside of the home. Inside, they look at the home’s features, take measurements and take note of its condition. Outside, they look at the home’s condition and take measurements.

Appraisers take pictures of the home, both inside and out, and then they also take pictures of comparable homes that sold in the area recently. They look for homes that are as close as possible to the same size and features of the subject home.

Appraisers make adjustments to the subject property’s value (up and down) based on features it has better or worse than the comparable sales.

The appraisal report is what lenders use to determine how much you can borrow. For example, if they said you qualify for a loan that’s 80% of the home’s value and the appraisal comes in at $250,000, you could borrow $200,000.

Now, if you already agreed on a higher sales price, there could be a problem. Lenders won’t use the sales price to determine how much you can borrow.

What Can You Do If the Appraisal Comes Back Low?

It happens all of the time, especially in today’s seller’s market. Values come in lower than the agreed upon sales price, making it difficult for buyers.

So, what can you do if you have an appraisal gap?

What Is an Appraisal Gap?

We’ve seen a lot of this in 2022 – a home appraises for less than the sales price because there was a bidding war or so much interest in the home that it drove the price up.

The appraisal gap is the difference between the appraised value and the contracted price. There are a few common options buyers use.

• Renegotiate the sales price – Most buyers go back to the seller and tell them the appraised value the appraiser came up with and try to renegotiate. Before the issue with low inventories and crazy high demand, sellers would usually renegotiate the price and meet the appraised value. Occasionally a seller would fight the appraisal and ask for a second opinion.
• Pay the difference – If the seller won’t budge on the price, you always have the option to make up the difference. Let’s say there’s an appraisal gap of $10,000. If you have the assets, you can invest the additional $10,000 on top of the down payment you were already making.
• Walk away – If you don’t have the money to make up the difference and the seller won’t renegotiate, you can walk away from the sale. If you had an appraisal contingency on the contract, you will keep your earnest deposit and be able to look for another home.

There’s one more trick though.

If you were making a larger down payment than the minimum required, you could lower your down payment amount and use the money to make up the difference from the appraisal gap.

For example, if you agreed to pay $300,000 for a home and you were making a 10% down payment, you’d be putting down $30,000.

Now if the appraisal came back at $285,000, you’d be $15,000 short. If you don’t have $15,000 to make up the difference but you still want to buy the home, you could make the minimum required down payment of 3% or $8,550 (3% of $285,000) and make up the $15,000 shortage, for a total of $23,550 down.

There are downsides to this though.

• You’re paying more for a house than it’s worth. Make sure the homes in the area usually appreciate and that homes around the home you’re buying are worth more. Don’t overinvest in an area where values don’t increase, or you might always be upside down, owing more than the home is worth.
• Your mortgage payment will be higher. When you make a smaller down payment, you increase your loan amount which increases your mortgage payment. If you really want the house, though, it might be worth it to you.
• You might pay mortgage insurance – Depending on the type of mortgage program you use; you might have to pay mortgage insurance if you decrease your down payment below 20% to make up for the appraisal gap.

Reasons Appraisals are Good for Buyers

At this point, you might think that appraisals are just a hurdle to get the home you want, but they actually protect you.

Even though they are put in place to protect lenders, so they don’t lend money on homes that aren’t worth as much as you’re paying, they protect you too.

Without an appraisal, you wouldn’t know a property’s fair market value. What if the seller is asking an inflated price for the property? An appraiser can tell you when you’re paying too much for it and then you can decide how to proceed.

Appraisals also tell you a home’s condition and if it’s worth investing in. If the appraiser finds issues, like a roof with little life left on it, or the home doesn’t measure out to as large as the seller listed it for, you may want to back out.

The appraiser is like your backup – letting you know if a property is or isn’t worth it.

3 Things to Know About the Appraisal

As a buyer, the appraisal is an important tool to help you. Here’s what you should know about it and how to handle it.

1. If you have an appraisal contingency in your contract, you can back out of the sale and not lose your earnest money. Don’t be afraid to make a bid but try not to get carried away in a bidding war. Know that with an appraisal contingency in the contract, though, you can back out of the sale if the appraisal comes in too low.
2. You can appeal the appraisal. If you’ve done your homework and you think the appraiser is off course with his assessment of the property, you can ask for an appeal. It helps if you have facts and figures to share with the appraiser to prove why you think he/she is wrong with the value.
3. You can’t control the appraisal. There are certain factors you can control when you buy a house, but the appraisal isn’t one of them. The appraisal is in the appraiser’s and seller’s hands. Make sure the data provided is accurate and then just be patient. If the house doesn’t appraise for what you want, it might not be meant to be.

Who Pays for the Appraisal?

Even though the appraisal is mostly for the lender (and a little bit for the buyer), the buyer pays for it. The average appraisal cost $300 – $500 and becomes a part of your closing costs. If you can’t afford it, you can ask the seller to cover it for you or see if you can wrap the cost into your loan amount.

Key Takeaway

The appraisal is a key factor in the mortgage process. Use it to your advantage so you don’t buy a home that’s not worth as much as you’re paying. In the current seller’s market, there are a lot of inflated prices. Don’t get caught up in the excitement and make sure you only pay for a home what it’s worth.