In the competitive world of real estate, waiving the appraisal gap can be both a strategic move and a significant risk for home buyers. This practice, often employed in hot housing markets, involves agreeing to cover the difference between the appraised value of a home and the purchase price. While it can make an offer more attractive to sellers, it also exposes buyers to potential financial pitfalls.
An appraisal gap occurs when the appraised value of a home is lower than the agreed-upon purchase price. For instance, if a buyer offers $500,000 for a home, but the appraisal comes in at $470,000, there is a $30,000 appraisal gap. This gap can complicate the home buying process, especially when financing is involved, as lenders typically base their loan amounts on the appraised value, not the purchase price.
The Appeal of Waiving the Appraisal Gap
In a seller's market, where demand outstrips supply, buyers often face fierce competition. Waiving the appraisal gap can make an offer stand out. It signals to the seller that the buyer is committed to proceeding with the purchase, even if the appraisal is lower than expected. This can be particularly appealing in bidding wars, where multiple offers drive up prices beyond appraised values.
The Risks Involved
However, waiving the appraisal gap is not without risks. Buyers who waive this contingency must be prepared to cover the difference out of pocket. This can be a substantial financial burden, especially if the gap is large. For example, if a buyer agrees to cover a $30,000 gap but only has $20,000 in savings, they may face significant financial strain or even be unable to complete the purchase.
Moreover, waiving the appraisal gap can lead to negative equity, where the buyer owes more on the mortgage than the home is worth. This situation can make it difficult to refinance or sell the home in the future without incurring a loss.
Strategies to Mitigate Risks
To mitigate these risks, buyers can consider several strategies:
Appraisal Gap Clauses: Instead of waiving the appraisal gap entirely, buyers can include an appraisal gap clause in their offer. This clause specifies the maximum amount the buyer is willing to cover if the appraisal is low. For example, a buyer might agree to cover up to $10,000 of an appraisal gap, providing some protection against large discrepancies.
Financial Preparedness: Buyers should ensure they have sufficient funds to cover potential gaps. This includes having a financial buffer beyond the down payment and closing costs to handle unexpected shortfalls.
Negotiation: If an appraisal comes in low, buyers can attempt to renegotiate the purchase price with the seller. While this may not always be successful in a competitive market, it is worth exploring.
Challenging the Appraisal: If buyers believe the appraisal is inaccurate, they can request a review or a second appraisal. Providing evidence of comparable sales that support a higher value can sometimes result in a revised appraisal.
Expert Insights
Real estate professionals emphasize the importance of understanding the implications of waiving the appraisal gap. Hillery Dorner, a real estate attorney, notes, "Waiving the appraisal gap shifts a huge amount of risk onto the buyer. It's crucial to cap the buyer's liability to avoid overpaying significantly for a property". Similarly, Bill Banfield from Rocket Mortgage advises, "Buyers should ensure they have the financial means to cover any potential gaps and should not waive the appraisal gap without fully understanding the risks involved".
Waiving the appraisal gap can be a powerful tool in a competitive real estate market, but it comes with significant risks. Buyers must carefully weigh the potential benefits against the financial implications and consider strategies to protect themselves. By being well-prepared and informed, buyers can navigate the complexities of appraisal gaps and make sound decisions in their home buying journey.
