When you are buying a home, the purchase price you agree to with the seller is an important part of the transaction. However, your mortgage lender may also require an appraisal to determine the property’s estimated value.
Sometimes, the appraisal comes in lower than the agreed-upon purchase price. This can create an appraisal gap and potentially affect your financing, your down payment, or even whether the transaction moves forward as originally planned.
Understanding what happens when a mortgage appraisal is lower than the purchase price can help you prepare for your options.
What Is a Home Appraisal?
A home appraisal is an independent professional opinion of a property’s value.
Mortgage lenders often require an appraisal as part of the loan process because the home generally serves as collateral for the mortgage. The lender wants to evaluate whether the property’s value supports the amount being financed.
An appraiser may consider factors such as:
- The home’s location
- Its size and condition
- Features and improvements
- Recent sales of comparable properties
- Local market conditions
The appraised value may be similar to the purchase price, but it is not guaranteed to match it.
What Does It Mean When an Appraisal Comes in Low?
A low appraisal occurs when the property’s appraised value is less than the price the buyer agreed to pay.
For example, imagine you agree to purchase a home for $400,000, but the appraisal determines that the home’s value is $380,000.
That $20,000 difference is often referred to as an appraisal gap.
The lender may base certain aspects of the loan on the lower appraised value rather than the higher purchase price. As a result, the buyer and seller may need to reconsider how the transaction will move forward.
Why Does a Low Appraisal Affect Your Mortgage?
Mortgage lenders generally use the property’s value when determining how much they are willing to lend relative to the home.
If the appraisal is lower than the purchase price, the lender may not automatically increase the loan amount to cover the difference.
Using the previous example, if you agreed to buy the home for $400,000 but it appraises for $380,000, your financing may be based on the lower value.
This could mean you need to:
- Bring additional cash to closing
- Renegotiate the purchase price
- Change the structure of the transaction
- Explore other financing options
- Decide whether to move forward based on the terms of your purchase agreement
Your specific options will depend on your mortgage program, financial situation, and contract terms.
Can You Renegotiate the Purchase Price?
In some situations, a low appraisal may give the buyer and seller an opportunity to renegotiate.
The seller may agree to reduce the purchase price closer to the appraised value so the financing can move forward more easily.
However, the seller is not always required to lower the price. Their willingness to renegotiate may depend on factors such as local market conditions, competing buyers, and the terms of the purchase agreement.
In some cases, the buyer and seller may agree to meet somewhere in the middle.
For example, the seller may reduce the price by part of the appraisal gap while the buyer agrees to contribute additional cash toward the remaining difference.
Can You Pay the Difference in Cash?
Depending on your financial situation, you may be able to cover some or all of the appraisal gap with additional cash.
For example, if the home appraises for less than the purchase price, you could choose to bring additional funds to closing to make up the difference.
However, doing this can reduce your available savings after closing.
Before deciding to cover an appraisal gap with cash, consider:
- How much money you will have remaining in savings
- Your emergency fund
- Moving expenses
- Future home repairs
- Other closing costs
- Your long-term financial goals
Using all of your available cash to close on a home could leave you with less flexibility after becoming a homeowner.
Can You Challenge a Low Appraisal?
If you believe an appraisal contains errors or does not accurately reflect the property, you may be able to ask your lender about the process for requesting a reconsideration of value.
For example, there could be concerns involving:
- Incorrect property information
- Missing home improvements
- Inappropriate comparable sales
- Relevant information that was not considered
A challenge does not guarantee that the appraised value will change. However, discussing the situation with your mortgage professional can help you understand whether additional information may be submitted for review.
What Is an Appraisal Contingency?
An appraisal contingency is a provision that may be included in a purchase agreement to address situations where the property does not appraise for the expected value.
Depending on the terms of the agreement, the contingency may give the buyer certain options if the appraisal comes in below the purchase price.
The exact language and protections can vary from one contract to another. Buyers should understand the deadlines and requirements associated with any appraisal contingency before moving forward.
Your real estate professional and other appropriate advisors can help you understand the terms that apply to your specific transaction.
Can the Seller Challenge the Appraisal?
A seller may also disagree with a low appraisal.
Depending on the situation, the seller may be able to provide additional information about the property or recent comparable sales for consideration through the lender’s established process.
The seller may also decide not to reduce the purchase price and instead wait to see whether another buyer is willing to purchase the home under different terms.
Because every real estate transaction is different, there is no guarantee that a low appraisal will automatically lead to a price reduction.
How Can Buyers Prepare for a Potential Appraisal Gap?
A competitive housing market can increase the possibility of appraisal gaps, particularly when buyers offer more than recent comparable sales might support.
Before making an offer, consider reviewing the local market with your real estate professional and understanding how much flexibility you have in your budget.
You may also want to avoid committing more cash to an appraisal gap than you can comfortably afford.
Preparation can help you make decisions based on your financial situation rather than feeling pressured to react quickly after a low appraisal.
Work With Your Mortgage Professional
A low appraisal does not necessarily mean that your home purchase is over.
Depending on your circumstances, there may be several possible paths forward. The right option may depend on your loan program, available funds, purchase agreement, and whether the buyer and seller can reach a new agreement.
A knowledgeable mortgage professional can help explain how the appraisal affects your financing and what adjustments may be possible.
Conclusion
When a mortgage appraisal comes in lower than the purchase price, it can create challenges, but it does not automatically end the home purchase.
You may have options such as renegotiating with the seller, bringing additional cash to closing, requesting a review of the appraisal, or making another adjustment based on your financing and contract terms.
Understanding the role of the appraisal before making an offer can help you prepare for potential surprises and make more confident decisions throughout the homebuying process.
