In this market, many home buyers are still paying above fair market value for homes, which leads to a gap between the sales price and the appraised value, called an appraisal gap. So, what does that mean, and how can it factor into your loan amount? Let’s jump into it.
In a normal market, the sellers and buyers would typically negotiate the sales price of a home if the appraisal came in lower than the sales price. However, today, many buyers are signing appraisal addendums as part of their contract offer, stating that they will pay for any appraisal gaps. In this scenario, the sales price stays the same and the buyers pay the difference.
If a buyer is using a 100% financing loan (i.e. VA or USDA), the math is easy – they just pay the appraisal shortage, and the lender requires them to sign a document stating that they understand they are paying above fair market value for the property. However, if they are using a loan program with a required down payment amount, the down payment will be based on the appraised value if it’s lower than the sales price. Therefore, the buyers have to pay the appraisal gap plus the required down payment at closing.
Let’s look at an example, shall we:
Let’s say we have a Conventional loan with a required 3% down payment, and it APPRAISES FOR THE SALES PRICE:
Sales Price is $300,000, Appraised Value is $300,000. Total Required Down Payment from Borrower (that 3% for the Conventional loan) is $9,000 (not including closing costs). Easy breezy, lemon squeezy.
Now, let’s say we have a Conventional loan with a required 3% down payment that APPRAISES FOR LESS THAN SALES PRICE:
So, the Sales Price is $300,000, the home appraises for $290,000 – so there’s a $10k difference there. The conventional loan requires 3% down, based on the appraised value, which is $8,700, PLUS the $10,000 appraisal gap, for a total downpayment of $18,700, not including closing costs.
Many buyers and even real estate agents get confused and believe that as long as the house appraises for the loan amount, it won’t affect their numbers. However, in the lending world, the rule on a purchase is that the loan terms & down payment are based on either the appraised value or sales price – whichever is lowest!
Of course, this may not be the best option or even feasible for all buyers, so you should always talk with your lender and Realtor® to discuss your specific case and what’s right for you.
If you have any questions or would like to see how much home you could comfortably afford, visit https://www.homespiremortgage.com/loan-officer-search/ to find a Homespire Loan Officer near you.