How to handle a valuation gap as a home buyer
How to handle a valuation gap as a home buyer

Valuation spreads in the current market

Rapidly rising home prices have led to an increasingly common challenge for home buyers and sellers: the valuation gap.

When a home’s appraised value is lower than the contracted purchase price, buyers must either cover the difference, renegotiate, or walk away.

Fortunately, there are a multitude of ways to close a valuation gap. Buyers should work closely with their real estate agent or agent to structure their offer to protect against valuation discrepancies – and have a contingency plan in case this happens.

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What does a valuation gap mean?

A valuation gap occurs when the appraised value of a home for sale is lower than the contractual purchase price agreed upon by the buyer and seller.

Valuation gaps are common in a hot real estate market. When the number of buyers exceeds the inventory of homes available on the market, home prices rise rapidly.

As home prices rise at a faster rate than recent comparable home sales, appraised values ​​are struggling to keep up. And, as buyers bid on the asking price to win these homes, valuation discrepancies can easily occur.

Example of a valuation difference

For example, let’s say the list price of a house you are considering is $300,000. To make your offer more attractive, you submit an offer of $325,000 with a 5% down payment.

The seller accepts your offer, but the appraisal comes down to just $305,000. Unless the seller agrees to lower the price, you will need to find additional funds.

  • Purchase price: $325,000; 5% down payment = $16,250
  • Appraisal value: $305,000; 5% down payment = $15,250
  • Difference between the purchase price and the expertise: $20,000
  • Total cash needed (down payment + valuation difference): $35,250

However, you don’t always need to cover the entire valuation difference in cash.

Jon MeyerCertified MLO and loan expert from The Mortgage Reports, explains that “covering the difference out of pocket is only necessary when you make the minimum down payment allowed by your loan program.”

If you put down a 10% down payment, for example, but your loan program only allows a 3% down payment, you can take some of the money you’ve saved for the down payment and apply it valuation gap. You would end up with a larger mortgage, but it could help you secure the home you want.

What is a valuation difference clause?

A valuation variance clause can be written into the purchase contract to help guard against a low valuation. The clause states that the buyer will cover the difference between the appraised value of the house and the purchase price, up to a certain amount.

Here is an example of a valuation difference clause:

Buyer and Seller agree that if the appraised value returns below the purchase price, the buyer agrees to pay up to $20,000 above the appraised value, but not to exceed the purchase price .

Valuation gap clauses can help strengthen your bid in a bidding war. This gives the seller an extra level of confidence that the deal won’t fail due to a low rating. And it can protect you, the buyer, from having to renegotiate the purchase price or losing to another bidder.

Why appraisals are necessary in real estate

Unless you are paying cash for your new home, your lender will require an appraisal.

Home appraisals are one of the most important guarantees for the buyer and the lender. Using a systematic appraisal process, appraisers prevent both parties from overpaying.

For home buyers, an appraisal determines the value of the home you are buying. This protects you financially, especially if there is a substantial difference between the value of the home and what you have agreed to pay.

For lenders, an appraisal confirms that the selling price is correctly aligned with the value of your home based on condition, features and location. The appraisal also lets your lender know that your home can be sold to cover losses if you default on your mortgage.

My house is too low. What do I do now?

A seller’s market occurs when the demand for homes exceeds the supply in the market. The resulting eavesdropping wars can lead to a rapid increase in home values. When this happens, appraisers often struggle to determine true market value, resulting in low appraised values.

But what exactly does it mean for you as a buyer when the valuation is lower than the purchase price?

As a buyer, you may need to set aside more money. This is because your lender will calculate the loan-to-value (LTV) ratio based on the appraisal valuenot the purchase price.

But you won’t always have to pay the full spread out of pocket.

5 ways to handle a valuation gap

As a buyer, you can take several paths in the event of a valuation discrepancy.

1. Lower your down payment percentage

One option for the buyer is to lower their down payment percentage and use the extra money to cover the valuation gap.

For example, suppose you plan to put 20% off a $400,000 offer. That’s $80,000 in pocket. But the estimated value is only $380,000. Well, instead of using the entire $80,000 as a down payment, you can use $20,000 of that money to cover the valuation gap in cash. This leaves you with a $60,000 (15%) down payment on your loan.

The downside to this strategy is that if you reduce your down payment to less than 20%, you will have to pay for mortgage insurance, at least temporarily. But remember that the PMI can be canceled once you reach 20% home equity. And while it can help you secure a home in this hot market, the temporary PMI may be worth the cost.

“That tends to be the most common option,” says Meyer.

2. Pay the difference in full

Regardless of the appraisal value, as a buyer you can simply pay the difference between the contract price and the appraisal value. If an appraisal shortage is significant, however, buyers may not be able to cover the full amount.

3. Renegotiate the terms with the seller

The buyer and seller can essentially start negotiations again now that the appraised value has been determined. In a buyer’s market, the seller may agree to lower the price to match the appraised value. In a seller’s market, however, the owner is more likely to go with a buyer who has extra cash and can cover the difference out of pocket.

4. Include a Valuation Difference Clause

As described above, a valuation gap clause can prevent the buyer and seller from having to renegotiate their purchase agreement when a valuation is too low. We explain how this works in more detail below.

5. Terminate the contract

Assuming you are still within your assessment contingency period, you can simply opt out of the agreement. This is probably the least attractive option, but it may be the only one if you are unable to cover the valuation gap using one of the strategies below.

How Buyers and Sellers Benefit from an Expertise Gap Clause

If a buyer cannot afford to make up the difference between the contract price and the appraised value, the highest bid that was accepted by the seller is now rendered virtually useless.

Therefore, if a buyer wants their offer to be considered, high offers are no longer sufficient.

This is when a valuation gap clause can be invaluable. It can be used to reduce or eliminate the risk of the seller wasting time and money due to a poor review.

For a buyer’s offer to even be considered, many sellers expect to see a valuation gap clause as part of their contract offer. The clause states that they agree to cover a valuation difference up to an agreed amount.

“Not only does a valuation gap clause increase the likelihood that your offer will be considered, but it’s also really the only way to be competitive in this market.”

–Allison Barnett, EXP Realty

According to Allison Barnett of EXP Realty in Marietta, Georgia, “Writing valuation gap clauses into offers has become routine. Not only does a valuation gap clause increase the likelihood that your offer will be account, but it’s also really the only way to be competitive in this market.

More than ever, having a good real estate agent is imperative for buyers in this market, says Barnett. “Not only can a real estate agent help structure a deal so that the buyer’s offer is on track, but they can also make sure the buyer doesn’t pay too much.”

Barnett goes on to say, “Equally important, however, is how a valuation gap clause protects buyers. Not having something in writing that explicitly states what the buyer will cover in the event of a low appraisal can mean wasted time and money on home inspections and appraisals when a deal fails.

Valuation spreads: the end result

As bidding wars become the norm, sale prices continue to be pushed well above market value.

For sellers, rising home prices seem like great news. But this is not the case unless the buyer can cover the difference in the event of a bad evaluation.

For buyers, inflated home prices that translate into low appraised values ​​can mean you may have to end a transaction and start over.

A valuation gap clause not only gives the seller a guarantee that the deal will not fail due to a low valuation, but it also saves you from having to go back on the deal or cover the whole thing. of the difference.

Valuation gap clauses can be the key to making (and winning) a competitive offer in a boiling real estate market.

The information contained on The Mortgage Reports website is provided for informational purposes only and does not constitute advertising for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent company or affiliates.


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