Overcoming a Low Appraisal

It's weeks since you put your house "Under Contract," the home inspection went well, you are getting ready to pack things up and you get notice that your home under appraised.  Now what?

No matter whether you are the buyer or the seller, this is a problem that affects everyone.  The appraisal is the professional valuation of a home by a third party.  This is normally required by a lender, paid for by the borrower and used to make sure that the value of the home constitutes the sales price in order to complete the loan.  If a home is to under appraise, that means that the contract sales price is higher than the valuation provided by a licensed appraiser and that the difference is going to have to be made up in order to ascertain the loan.

For Example:  There is a contracts sales price of $300,000 with the buyer putting $10,500 (3.5%) down for an FHA Loan.  The appraised value comes in at $290,000.  Since the FHA can only lend up to 96.5% of the value of the home, this leaves a $10,000 gap between the buyer and their ability to get a mortgage.

How to Remedy an Appraisal Issue

There are many ways around this.  As always in a real estate negotiation, you have the right to request the other party to address the issue, address the issue yourself, negotiate or back out of the deal.

• The seller has the option to reduce the contract price to $290,000 which would then meet the FHA criteria allowing the buyer to move forward

• The buyer has the option to leave price as is and bring the extra $10,000 to the closing table

• Both parties have the option to negotiate, for example maybe splitting the difference 50-50.  The seller would reduce the contract price to $295,000 and the buyer would bring an extra $5,000 to the table.

• The parties have the right to dispute the appraisal.  Some times this is a tough battle to fight because even if there are certain comps to support your contract price, certain banks have specific criteria depending on the type of loan that might exclude the comps that you are referring to.  This is a good option if there is a significant difference in the pricing.

• If no attempts to remedy the issue are successful, the buyer has the right to cancel the contract on the grounds that they are unable to obtain a mortgage commitment.

Who is responsible for making up the difference?

Unfortunately, there is no right or wrong answer but in my experience, there are some unspoken rules that you can use to set your expectations.

Conventional Negotiations - In the "normal" course of business, if a deal is made between two parties with traditional negotiation, a contract sales price under list price, no concessions or contingencies and a house under appraises, normally the buyer would be looking for the seller to make the concessions to close the gap.  They made every effort to make the seller happy but unfortunately they were asking too much for the home.

Home Sale Contingencies - This is very common because normally when buying a home, you need to sell your current home to have the funds for your next mortgage.  Unfortunately, accepting a home sale contingency for a seller can be much riskier than a non-contingency deal so in turn, buyers tend to pay a higher premium for a seller to take the risk.  In these instances, it may not be the seller's fault that the home under appraised and they most likely would be looking for the buyer to cover some, if not all of the difference.

Bidding Wars -  Bidding Wars are tough, sellers need to be conscious of the fact that there could be an appraisal issue and should choose their buyer accordingly but it shouldnt necessarily be all on the seller since the buyer was willing to put such a strong offer in.  This should not be looked at as a chance to re-negotiate and hopefully the buyer and seller can reach a mutual agreement on how to handle the difference.

Seller Concessions - A buyer can utilize seller concessions by essentially over paying on the purchase price in order to have the seller give money back to them as a discount towards their closing cost.  This is a very common with first time home buyers, VA members and people putting very little down on their loan.  To read more about Seller Concessions, click HERE. Example - Buyer Paying $255,000 for a house that is listed at $250,000 in hopes to get $5,000 back towards their closing costs.  If the house only appraises at $250,000, there is no room for the $5,000 concession to the buyer.  Is that the seller's fault? Not really, the seller shouldn't necessarily be penalized because the buyer tried to fluff the price for their benefit, but not everyone thinks the same. 

As in all real estate negotiations, you can either have the seller address it, the buyer address it, negotiate or back out of the deal.  It's as simple as that.

How to Avoid Appraisal Issues

Use a local lender who in turn will be using a local appraiser.  These professionals know the local markets and will normally avoid common mistakes out of area appraisers might make while valuing a home

Don't over price your home and be cautious of bidding wars and seller concessions.  None of these things are bad in and of themselves but make sure that you make smart decisions on a contract price or place stipulations in the contract which spell out what were to happen if an appraisal issue arises.

Ask your real estate professional if they think you are at risk of an appraisal issue prior to signing contracts.

In the case of a bidding war, the highest price isn't necessarily the best, try to chose the strongest buyer who might have the cash on hand to handle an appraisal issue or vet the buyers and make sure they understand the consequences of paying over asking price.