Because of the competition within the market for a limited number of homes, buyers and their agents are coming up with all kinds of unique and creative ways to make their offer stand up against other buyers. Late 2020 and early 2021 has been the most competitive market I've ever witnessed, and short of offering a first born child, there have been plenty of interesting contract provisions. Buyers are offering way over list price, waiving inspection items, paying for title insurance and guaranteeing a certain portion of the appraisal gap, if one comes up.
Simply put, an appraisal gap is the difference between contract/purchase price and the appraised price. Because a lender will not lend above the appraised amount, if there is an appraisal gap, it can put your contract to purchase the home in jeopardy. By guaranteeing to cover some of the appraisal gap (if it comes down to that) it can provide the seller some comfort that the contract will continue as planned, or at least help them understand that they won't be responsible to lower their price to meet the appraised value.
Example: A home is listed for $430,000. You put in an offer and it is accepted at $450,000. In the contract, as an enticement to get your offer accepted, you said that, "should the appraisal come in less than the purchase price, but above list price, buyer has $20,000 to cover any appraisal gap".
At this point there are 3 scenarios that you're faced with:
- Appraisal comes in at purchase price or above ($450,000+)
- Appraisal comes in less than purchase price but above list price ($440,000)
- Appraisal comes in less than list price ($420,000)
Option 1 is quite common, and most appraisers know that because the market is accelerating, that there is upward momentum and comparables should be adjusted for that. If it comes in at $450,000+, everbody is happy: the seller, you (the buyer), and the bank.
Option 2 also happens in an increasing market. An appraiser compares to recent comparables but because you offered above list price, the appraiser was just not able to justify it. The appraisal gap between contract price and appraised price is $10,000. This means that you will be responsible for bringing an additional $10,000 at closing to cover that appraisal gap. This is not the most ideal scenario, but you still have a house.
Option 3 happens occasionally but not often. Depending on the list price and the comparables, perhaps the appraiser just won't be able to confirm a price near purchase value. This is the least ideal scenario because there are further negotiations that are needed. Since an appraisal at $420,000 constitutes a $30,000 appraisal gap, you would be responsible for $20,000 of your appraisal gap commitment, but then there is an issue with the remaining $10,000. At that point, the seller could come down $10,000 to cover the difference, you could come up with an additional $10,000, or you can meet somewhere in the middle. It is not ideal for anyone. But if both parties want to continue with the contract, something has to be negotiated.
Because of the insane amount of competition out there, providing some appraisal gap (or waiving the appraisal all together) is a great way to beat out any other offers. You (and your Realtor) need to be confident in the value of the home, and hopeful that the appraiser sees it that way as well. And you have to be prepared to provide your entire appraisal gap coverage if it comes down to it. The benefit in providing an appraisal gap is that it can get your offer won, you don't have to keep seeing and losing out on houses, and you can finally move forward in a great, accelerating market.
It takes a lot of tact, preparedness, communication and confidence between you and your agent to provide appraisal gap coverage. It takes a lot of courage, but surviving and winning in this market also requires it!
If you want to get started with your next home search, reach out to me to get started - Jared@TheCraftBroker.com or 970.222.1049.
