As a new home buyer, a lot of questions may keep you up at night. What if we can’t find a house before our lease ends? What if we can’t find a place we like? What if we fall in love with a house and get bad news during the inspection? Rarely, do buyers ever wonder what happens if an appraisal comes in low. But this can be a stressful issue for anyone trying to finance a purchase.
What is a Home Appraisal and Why Do You Need One?
If you are obtaining a mortgage to purchase a home, a bank appraisal is a necessary evil. You see, your lending partner is going to highly invested in your purchase. For instance, if you are putting 5 percent down, the lender is bringing 95 percent to the closing table. That’s a lot of money! Understandably, your lender will want to do some research on your future home to make sure it is getting a decent deal. To do this, a bank will send out an appraiser to determine the fair market value of your property based on recent sales and comparable market data.
Why Would a Home Appraisal Come in Low?
Sometimes, the appraised price comes back lower then the agreed upon purchase price. Let’s say you offered to purchase a beautiful home for $390,000. After signing the purchase agreement and moving forward with your financing, the bank appraiser determines that the value is only $380,000. Why does this happen? There are a few reasons:
In hyper-competitive housing markets where there are multiple bids, the demand on a property can push the price tag up beyond what an appraiser determines it’s worth. You see, appraisers work off historical data and need to back up your purchase price with recently sold comparable houses.
Seasonal peaks can be another culprit. For example, early spring is the most common time for low appraisals in New England. The nice weather gets buyers out of the winter slump and all the fresh inventory and activity can drive prices upward. This makes it tough for appraisers who have to pull from winter sales to justify current values and seasonal pricing spikes.
Another reason your appraisal may come in low is if the appraiser missed the mark. Unfortunately, on most residential transactions, you are not able to choose the appraiser because as the buyer it’s a conflict of interest. Although, if the appraiser is new at the job or from out of town, he or she may make some oversights and come up with an opinion that doesn’t make sense. People make mistakes!
What if you are buying a truly unique and special piece of real estate. Again, appraisers must use historical data and comparable homes to build a case about value. In some situations, there simply are not enough comps to justify pricing. In that scenario, the appraiser will be conservative. How do you assign value to the smallest house in a seaside town with the best views? Or, what if the home you have under agreement looks like a medieval castle in a neighborhood of contemporary houses? How is the appraiser going to find anything comparable to your feudal abode?
What if Appraisal is Lower Than Purchase Price: Your Options
Getting a low appraisal is bad news because the lender will only provide a loan up to the appraised value, overriding your purchase price. Going back to the example provided earlier, who covers the $10,000 discrepancy between your offer at $390,000 and the appraisal of $380,000?
There are a few ways you can solve the problem and move forward. The first thing you want to do is scrutinize the appraisal. Do you see any glaring issues? Did the appraiser miss something or overlook a perfect comp? Speak with your lender to see if there’s anything you can do to get a second opinion and revisit the report. You may want to order a new appraisal if things are really out of whack.
If ordering a new appraisal doesn’t seem like the best path forward, you have some other options:
- Ask for a price reduction. Are the sellers motivated? The easiest solution is for them to drop the price down to the appraised value. If the situation is not competitive, you might be able to get the seller to reduce the sales price based on the findings within the appraisal report. This would be the best-case scenario for you! The deal would be even better than originally planned. If they won’t drop the price all the way, you may still be able to negotiate a reduction and meet them in the middle.
- Come out of pocket. If the seller isn’t motivated, or has plenty of backup offers waiting in the wings, he or she may tell you to take it or leave it. At that point, you need to decide if you can put the extra money down to cover the difference. Putting more money down will offset the low appraisal.
- Reconfigure your financing. What if you don’t have the money to come out of pocket? Unless you are already a low down payment purchaser, you may be able to work with your lender on a new program that frees up some cash. Rather than putting down the amount you intended, you can put down a little less and use the extra cushion to close the gap between the purchase price and appraisal price.
If all else fails, you can terminate the transaction, if you have a financing contingency.