What Is an Appraisal Gap?

Understanding the Appraisal Gap

An appraisal gap occurs when the appraised value of a home comes in lower than the agreed-upon purchase price. For example, if you have a contract to buy a home for $400,000 but the appraiser determines the home is worth $385,000, there is a $15,000 appraisal gap.

This matters because your mortgage lender will only lend based on the appraised value, not the purchase price. The lender uses the lower of the two figures to calculate your loan-to-value ratio. In the example above, the lender would base your loan on a $385,000 value, which means you need to come up with the $15,000 difference on your own or renegotiate the deal.

Why Do Appraisal Gaps Happen?

Appraisal gaps are more common in certain market conditions. Here are the most common causes:

• Competitive bidding wars: In a hot market where multiple buyers are bidding over asking price, the purchase price can outpace what comparable sales support. Buyers may offer $20,000 or $30,000 above asking, but the appraiser has to justify the value using recent comparable sales.
• Rapidly appreciating markets: When home values are rising quickly, the comparable sales used by the appraiser may be from closings two to six months ago, before the most recent price increases took hold.
• Limited comparable sales: In rural areas or neighborhoods with few recent transactions, appraisers may struggle to find truly comparable properties, leading to more conservative valuations.
• Unique property features: Custom homes, unusual layouts, or properties with features that are hard to compare (like acreage or outbuildings) can be difficult to appraise accurately.
• Emotional buyer decisions: Sometimes buyers simply fall in love with a home and offer more than the market data supports.

Your Options When Facing an Appraisal Gap

When an appraisal comes in low, you have several paths forward:

1. Pay the Difference Out of Pocket

You can bring additional cash to closing to cover the gap between the appraised value and the purchase price. This is the simplest solution but requires you to have extra funds available. Using the earlier example, you would need an additional $15,000 beyond your planned down payment and closing costs.

2. Renegotiate the Purchase Price

You can ask the seller to lower the price to match the appraised value or to meet you somewhere in the middle. The success of this strategy depends on market conditions and the seller's motivation. In a buyer's market, sellers are more likely to negotiate. In a competitive seller's market, they may have backup offers at the original price.

3. Challenge the Appraisal

If you believe the appraisal is inaccurate, you or your loan officer can submit a Reconsideration of Value (ROV). This involves providing additional comparable sales or factual corrections that the appraiser may have missed. Common grounds for a challenge include:

• The appraiser used comparable sales that are not truly similar in size, condition, or location
• More recent or more relevant comparable sales were available but not used
• Factual errors in the appraisal report (wrong square footage, missing features, etc.)
• The appraiser was not familiar with the local market

An ROV is not guaranteed to change the outcome, but it is worth pursuing if there are legitimate issues with the appraisal. Your loan officer can guide you through this process.

4. Walk Away

If your purchase contract includes an appraisal contingency, you can walk away from the deal and get your earnest money back. This is the safety net that appraisal contingencies provide. However, if you waived the appraisal contingency (common in competitive markets), walking away may mean losing your earnest money deposit.

5. Split the Difference

A common compromise is for the buyer and seller to split the appraisal gap. If the gap is $15,000, the seller might lower the price by $7,500 and the buyer covers the remaining $7,500 out of pocket. This keeps the deal together while sharing the burden.

What Is Appraisal Gap Coverage?

Appraisal gap coverage (also called an appraisal gap guarantee) is a clause in your purchase offer where you agree to pay the difference between the appraised value and the purchase price, up to a specified amount. For example, you might offer $400,000 with $15,000 in appraisal gap coverage, meaning you will cover up to $15,000 if the appraisal comes in low.

This is different from waiving the appraisal contingency entirely. With appraisal gap coverage, you are committing to cover a defined amount, which gives the seller confidence while limiting your exposure. If the gap exceeds your coverage amount, you can still renegotiate or exercise your appraisal contingency.

In competitive markets, including appraisal gap coverage in your offer can make it significantly more attractive to sellers, almost as powerful as waiving the appraisal contingency but with less risk to you.

How Different Loan Types Handle Appraisal Gaps

The way an appraisal gap is handled can vary by loan type:

• Conventional loans: The lender uses the lower of the purchase price or appraised value. You can cover the gap with cash, and your loan officer can submit an ROV if warranted.
• FHA loans: Same approach, but FHA appraisals also evaluate property condition, and any required repairs must be completed before closing. An FHA appraisal stays with the property for 120 days.
• VA loans: VA borrowers can cover the gap out of pocket. The VA also has a specific process for challenging appraisals through the Tidewater Initiative, where the appraiser notifies the lender before issuing a low value, giving the buyer time to provide additional comparable sales.

Tips to Protect Yourself

• Always include an appraisal contingency unless you have the cash reserves and confidence to cover a gap
• Research comparable sales before making an offer so you have realistic expectations
• Keep cash reserves beyond your down payment and closing costs to handle a potential gap
• Work with an experienced agent who can help you write a competitive offer without overexposing yourself
• Communicate with your loan officer early about your financial flexibility so you can move quickly if a gap arises

An appraisal gap is stressful but manageable. The key is understanding your options before it happens and having a plan in place. A good loan officer will prepare you for this possibility and help you navigate it quickly if it arises.