What Does Covering An Appraisal Gap Mean?

Over the past few years, there has been a lot of buzz around the term "appraisal gap coverage" due to the rise in home values and the competitive, multiple-offer environment. But what does it really mean?

 

When you purchase a home with a mortgage, the lender typically requires an appraisal to validate the purchase price and "protect" themselves to ensure that they are only loaning you what they are told the home is "worth" based on comparable homes that have sold. This is also to protect you so that you are not underwater on your home value before you even settle.

 

However, in a competitive market when home prices surge, the appraised value may fall short of the agreed-upon price, creating a gap that needs to be addressed. Therefore, offers are being made with stronger, more creative terms, such as providing assurance that any difference between the contract price and the appraised value (or up to a certain amount of the difference), will be made up in additional cash at settlement. Essentially, in order to get competitive against multiple offers, buyers are offering to cover the difference between the appraised value, and the contract price (ie "the gap"), so that the seller still gets the agreed-upon price. 

 

Covering an appraisal gap refers to the situation where the appraised value of a property is lower than the agreed-upon purchase price in a real estate transaction. When a buyer and seller agree on a price for a property, the buyer typically seeks a mortgage loan from a lender to finance the purchase. As part of the mortgage process, the lender will order an appraisal to determine the property's market value.

 

If the appraised value comes in lower than the purchase price, it creates an "appraisal gap." For example, let's say the agreed-upon purchase price is $300,000, but the appraised value is only $280,000. This means there is a $20,000 appraisal gap.

 

Covering the appraisal gap usually falls on the buyer, as it affects their ability to secure financing for the full purchase price. In some cases, buyers may have to contribute additional funds out of pocket to make up the difference between the appraised value and the purchase price. This is often referred to as making an "appraisal gap payment."

 

Alternatively, the buyer may negotiate with the seller to lower the purchase price to match the appraised value, thereby eliminating the appraisal gap. This can be done through renegotiating the terms of the contract or asking the seller to contribute towards closing costs or repairs to bridge the gap.

 

In certain competitive real estate markets, where multiple buyers are vying for properties, buyers may choose to cover the appraisal gap entirely, essentially paying the difference between the appraised value and the purchase price without renegotiating with the seller. This can help strengthen their offer and increase the chances of the seller accepting it.

 

It's important to note that covering an appraisal gap can have financial implications for the buyer, as they may need to bring additional funds to the closing table. It's advisable for buyers to carefully evaluate their financial situation and consult with their real estate agent and lender before deciding on how to handle an appraisal gap.



If you have some extra cash saved up, this may be a great option to consider if you find yourself in a competitive situation. It's important, however,  to understand the risk involved with covering an appraisal gap, along with your options if the appraisal does happen to come in lower (restructuring your loan amount, getting a gift, etc).

 

It's important that you speak with your lender before assuming you can actually make up the difference if the appraisal comes in low — you don't want to drain your entire savings account or rainy day fund in doing so.

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