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An appraisal gap occurs when a property's appraised value falls below its agreed-upon sale price, potentially derailing a mortgage and forcing the buyer to cover the difference in cash. Based on a June 2024 report, roughly 9% of home sales encounter this issue, with the risk being higher for starter homes. Understanding how to navigate a low appraisal is critical in today's market.
An appraisal gap is the difference between the contracted sale price of a home and the official market value determined by a licensed appraiser. This gap matters because mortgage lenders use the appraised value—not the sale price—to determine the maximum loan amount. If the appraisal is low, the lender will not finance the full sale price, leaving the buyer to pay the difference out-of-pocket or renegotiate the deal.
This situation became more common as the market cooled. During the peak competition of the pandemic, many buyers waived their appraisal contingency to make their offers more attractive. An appraisal contingency is a clause in a purchase contract that allows the buyer to back out without penalty if the appraisal comes in low. According to the National Association of Realtors®, the share of buyers waiving this protection fell to 19% in a recent month from 24% the previous month, indicating a return to more cautious purchasing.
A professional appraiser evaluates several key factors to establish a home's market value. These include the property's condition, square footage, number of bedrooms and bathrooms, and, most importantly, recent sales of comparable properties ("comps") in the immediate area. The process is methodical; for a standard property, an appraiser may spend several hours on research, a physical inspection, and compiling a detailed report. For unique properties, like a lakefront home, the process can take 10-12 hours or more due to the complexity of finding appropriate comps.
The challenge arises in markets with low inventory, where few similar homes have sold recently. In such cases, appraisers might need to expand their search for comps geographically or look at sales from a longer time period, which can lead to significant differences in valuation.
When an appraisal gap threatens a home purchase, buyers have several options, as illustrated by a real-world case. A buyer relocating to Charlotte, North Carolina, faced a $52,000 gap on a $750,000 home. The first appraisal, conducted by an appraiser who did not thoroughly inspect the unique property bordering a state park, used comparables from distant neighborhoods.
Based on our experience assessment, the buyer successfully navigated this by:
The risk of an appraisal gap is slightly higher for starter homes, at nearly 10%, compared to 7.1% for premium homes, which may reflect a higher risk of overpayment by inexperienced, first-time buyers.
Waiving an appraisal contingency is generally not advisable for buyers relying on a mortgage. It removes a crucial financial safeguard and commits you to covering any appraisal gap, even if it means significantly exceeding your budget. As Lawrence Yun, Chief Economist at the National Association of Realtors®, stated, this contingency is “generally advisable unless the property is clearly considered underpriced or multiple offers are expected.” For cash buyers, the decision is more flexible, but for most, retaining this contingency is a key protection.
The cost of an appraisal, typically between $300 and $500, is paid by the buyer but is a worthwhile investment to secure a fair mortgage.
Navigating the appraisal process successfully requires preparation. Always include an appraisal contingency in your offer to protect your earnest money deposit. If you are buying a unique property with few comparables, consider using a local lender whose appraisers may have better knowledge of the area's nuances. Be prepared to negotiate or provide additional data to support the home's value if the first appraisal is low. Ultimately, a thorough approach ensures you do not overpay for your new home.
