You’ve made an offer on your dream house, the inspection didn’t raise any serious issues, so now you only have to get the home appraised, wrap up your mortgage loan, and you can start planning your move.
If all goes well with the appraisal, that is.
How exactly could an appraisal derail your home purchase? Because a mortgage lender typically won’t lend you more than the home is worth, and an appraisal is the method used to determine a home’s value.
“They want to check their investment,” says Joanne McCoy, an agent in Lincoln, Nebraska, who works with 69% more single-family homes than the average agent in her area. “They want to make sure the property has appraised for the right value in case something goes wrong down the road and the bank ends up owning the house.”
Why do you need an appraisal?
As McCoy noted, banks want to protect themselves, which is why they require appraisals.
A mortgage is a secured loan — the house and land it sits on serve as collateral for the loan. If a homeowner defaults on their payments and the home goes into foreclosure, the bank takes possession of the collateral, also known as the property. And if the homeowner owes more on the loan than the house is worth in the current market, the bank will lose even more money. So an appraisal is a bank’s method of verifying the home’s value before the bank will agree to give the homeowner a loan.
If the appraisal comes in at or above the sales price, the deal can continue. But if it comes in below the sales price then you, the buyer, won’t be able to get a loan for the full sales price.
While low appraisals are a relatively rare occurrence under stable market conditions — a 2018 report by Fannie Mae indicates low appraisals occur about 8% of the time — it’s something to be aware of as a buyer.
And in a hot seller’s market where home inventory is low, buyers are competing to purchase property, and values are skyrocketing in a classic case of supply and demand — low appraisals are not unheard of. The COVID-19 pandemic sent the housing market into a frenzy and, with sales and valuation figures changing daily, the job of an appraiser has been more challenging than ever.
This doesn’t mean that a low appraisal is a for-sure obstacle if you’re buying a home today.
“We’ve seen low appraisals coming up more often than we have, let’s say, two years ago, but not at an alarming rate,” says Irwin, Pennsylvania-based real estate agent Adam Slivka. “In our area, appraisers have been pretty good about adjusting for the climbing market.”
That said, it certainly can happen.
You know what they say about an ounce of prevention being worth a pound of cure? When you’re working with an agent and they’re perhaps suggesting that you offer above asking price to become competitive; hopefully there’s an appraisal contingency as part of that agreement.
- Adam Slivka
Real Estate Agent
Real Estate Agent at C21 Fairways
- Years of Experience
- Average Price Point
- Single Family Homes
What happens if the appraisal comes in low?
So, what happens if you’ve beat out competing offers and now a low appraisal report is standing between you and your hopeful home?
Well, at this point, you have a few options. You can walk away from the house, put down more cash to make up the difference, or negotiate with the seller.
“You know what they say about an ounce of prevention being worth a pound of cure?” Slivka asks. “When you’re working with an agent and they’re perhaps suggesting that you offer above asking price to become competitive; hopefully there’s an appraisal contingency as part of that agreement.”
An appraisal contingency offers built-in protection for buyers should the appraisal indeed come back below the offer price.
“Let’s say you put in an offer on a $250,000 house and it appraises for $220,000,” says Slivka. “You don’t necessarily have to come up with the $30,000 in cash; you’ll have the alternative of going back to the seller and trying to renegotiate terms.”
Of course, if you’re planning to pay cash for a home, or you otherwise have cash at the ready, then a low appraisal doesn’t have to be a dealbreaker. You can choose to move forward with the purchase anyway, depending on how badly you want the home and how comfortable you are with the gap in numbers.
“If it’s something like $20,000 over your appraisal, it may not be that important because in a couple of years — or maybe even within a year — of appreciation, even if you’re ‘overpaying,’ the house could be worth that amount.”
As always, talk to your agent if you’re feeling unsure about how to proceed after a low appraisal. Sometimes it’s best to walk away, but sometimes it may be worth pressing on.
If you’re in this situation and wondering what to do, here are the stories of six buyers who faced the decision about what to do when their appraisal came in low.
Cross-country relocation with a hitch
Abra had just graduated medical school and been accepted to the residency program in Lincoln, Nebraska. They flew down and stayed with family while their agent, McCoy, showed them several homes. After finding one they liked, they made an offer with an escalation clause. This means that if the seller gets a better offer (up to a predetermined limit), the offer price automatically “escalates”; the seller still gets their better deal, and the original buyer doesn’t lose the house.
“The list price was $198,000,” Robbins says, “and we offered $200,000, with an escalation clause.” Three other offers drove the price up to $210,500.
In their escalation clause, David and his wife said they would pay up to $3,000 over the appraisal, but they never expected that to truly happen.
The appraisal came in at $205,000, however. Robbins thinks that a fast-moving market, with comparables that lagged actual market conditions, influenced the low number.
“We wish we hadn’t gone up to $3,000 above the appraisal,” he admits, but they didn’t think about walking away. “We didn’t want to rent, and we wanted our monthly payment to go into equity.”
McCoy says that one of the first things she’ll do when an appraisal comes in low is contact the listing agent and start a new discussion. The listing agent will typically ask if the seller will agree to reduce the price to the appraisal value, “which is what most buyers expect the sellers to do.”
“But the seller may or may not agree to that, and the buyer options are to make up the difference,” she adds. In this case, the seller came down in their price from $210,500 to meet them at $208,000, $3,000 above the purchase price, and the Robbins made up the $3,000 difference out of pocket.
An investment deal on the line
Justine Chan is an experienced real estate investor who ran into an issue when buying a residential building in South Bronx, New York, in July 2019. She’d offered the seller’s asking price and hadn’t included an appraisal contingency in her offer. But then the appraisal came in 8% below the offer price.
She thinks the appraisal came in low because “the comps were difficult, as this was the nicest building in the area.” It was only ten years old, much newer than the comparables. She still wanted the building, so she decided to ask the seller for a $5,000 credit at close so that she could have some extra cash reserves after the purchase. The seller accepted her offer and gave her $5,000 back at closing.
Oftentimes, sellers will be willing to negotiate with a buyer because they know another buyer will likely encounter the same problem with an appraisal. And it can be tough for many buyers to bring more cash to the table, particularly if they’re home shopping with a strict budget. The seller knows that if they don’t negotiate, they could torpedo the deal, waste time with their property off the market, and lose the interest of other buyers.
Justine says that she’d absolutely make the same decision again. “I researched the comps used and still felt confident that my offer price was right,” she says. And as an investor, she had the cash available to make up the difference.
Multiple offers drive up the price
If you’re buying in a seller’s market, you go into it knowing that you might have to sweeten the deal to win a desirable house.
When Sarah Yost and her fiance walked up the front path to an open house, they knew it was the home for them. But the listing agent told them that the seller had already received several aggressive offers — and, in fact, had almost canceled the open house. To beat out the other buyers, they had to write an impressive offer.
“The asking price was $279,000, and we offered $300,000 with an escalation clause,” Sarah says. As mentioned, an escalation clause gives the buyer the opportunity to beat out another buyer’s higher offer, and this clause said that they would beat any other offer by $1,000. They also waived the home inspection and agreed to pay $5,000 above the appraisal.
A heated bidding war, with multiple rounds of offers, drove the price up to $323,000, a full $44,000 more than the asking price. The large gap between the asking price and offer made several appraisers nervous, and they wouldn’t even appraise the house. When the bank finally found an appraiser, the home appraised at $300,000.
Sarah attributes the issues with the appraisal to the home’s unique nature. It wasn’t a ranch or split-level house, like most of the comps; instead it was a mid-century modern home with high ceilings. Plus, the majority of its square footage was below grade; even though the home had a walkout basement, in Nebraska, these types of basements don’t count toward the home’s total square footage. “So while our upper level was 800 square feet, the lower level of 1,300 square feet didn’t count toward our appraised value,” she explains.
Negotiations resumed, but the seller wouldn’t budge on price, confident that they could go back to the other interested buyers. In the meantime, Sarah and her partner did more research on the house and discovered sewer problems from 2018. At that point, the seller provided them with updated seller’s disclosures that revealed the house had more issues than they’d initially thought.
Armed with this new information, they were able to talk the seller down to a $312,000 price with the $300,000 appraisal and decided to make up the $12,000 difference in cash.
McCoy says that if the buyer has the extra cash and an appraisal comes in low, it could be a good idea to use that cash to make up the difference for several reasons. “Maybe there’s some updating to the home that the appraiser doesn’t give much value to,” she explains, “but the buyer says — look, this is stuff I’d have to pay for on another house, and it’s already done here.”
The couple closed in March of 2020 after pushing for a quick close due to COVID-19. They wish they’d done more due diligence on the house and have had a few surprises since moving in (such as a leaking roof). But they have such a great rate on their mortgage that Sarah thinks they’ll save money in the long run.
When the appraisal comes back lower than the offer, it can feel like the end of the world. But you do have options, up to and including walking away from the purchase.
PMI saves the day
In January 2021, Julie Marsh set out to buy a home in Parker, Colorado that appraised for $30,000 under the contract price of $395,000.
Though there was a backup offer on the table, the seller agreed to renegotiate and reduced the sales price by $5,000, leaving a $25,000 appraisal gap. Marsh was already putting down $79,000 cash, so her lender offered to move forward with the loan if she agreed to private mortgage insurance.
“We could have put down more cash,” says Marsh, “but the PMI was so low — something like $60 per month — that it made more sense to proceed with the gap.”
Marsh attributes her lender’s comfort level to her high credit score and low debt-to-income ratio, and she says she’s happy with her purchase despite the low appraisal.
“The house has now appreciated by $100,000 over our purchase price, so we made a good decision.”
Tapping into emergency funds
Homebuyer Erik Nilsson decided to proceed with his recent purchase of a home that appraised low by dipping into his savings.
Nilsson says that when the house appraised $12,000 below the sales price, he tried to renegotiate with the seller.
“Since the appraisal came in low, I argued that the house was overpriced and the original ask was way above the home’s actual value,” Nilsson explains. “I was hoping the seller would meet me halfway and split the difference, but they were pretty adamant and wouldn’t budget beyond reducing the price by $4,000.”
Since he wasn’t willing to let go of the home due to its favorable location in a desirable suburban neighborhood, Nilsson tapped into his emergency fund to make up the difference.
“I had already reserved most of my savings for the down payment and was relying on my home loan to finance everything else during the homebuying process,” says Nilsson. “The additional $8,000 I coughed up almost depleted my emergency savings, but it was my only option when the appraisal value came in low and the seller refused to meet it.”
Meeting in the middle
“It was actually my listing, and we’d listed this townhouse at $495,000. Two offers came in and the one for $505,000 won. The appraisal came back at $495,000 — right where we’d listed it — and both sides gave up $5,000 to meet in the middle at $500,000,” says Robins.
He explains that this is a typical example of what happens when an appraisal comes in low — there’s usually a willingness from both buyer and seller to accommodate the other side and make the sale happen.
Compromise is often possible, and your agent is your best resource
While each of these homeowners eventually decided to buy the property, their agent helped them negotiate and receive concessions from the seller based on the low appraisal.
And sometimes a solution can be found even if the seller can’t or won’t budge on price.
“You can always appeal the appraisal,” says Slivka. “The problem we’ve always found is that an appraisal is, to a large extent, an opinion of value. And probably from a lender standpoint, it’s more of a risk analysis than actual true value of the home. So you need to find something that the appraiser may have screwed up — maybe the house is 1,800 square feet and they were comparing it to something that was 1,500 square feet.”
Slivka stresses that it’s important to dispute based on actual facts — such as the size or amenities of a house — rather than lifestyle fit and finish preferences.
“It’s hard to really prove that, oh, some luxury vinyl tile is worth $X more than carpet,” he says.
In other words, it’s easier to make a case for your appraisal appeal if you can argue that this particular house has, for example, four bedrooms while most neighboring properties only have three — not the fact that it has granite countertops in the kitchen rather than quartz.
That’s why — unusual homebuying situation or not — you’ll always want a great agent on your side.
Header Image Source: (Greg Rosenke / Unsplash)