During a home purchase transaction, a mortgage lender will request a home appraisal to ensure that the amount being lent for the home does not surpass the home's true market value. A home appraiser acts as an unbiased third party and will assess components of the house, such as size, condition, improvements, upgrades, and even sale prices of comparable homes in the area. When the appraised value of the home comes in at a lower amount than the contracted sale price, this is called an appraisal gap. In today's housing market, supply is low, demand is high, and home prices are increasing to record levels. In May 2021, almost 20% of home sale transactions nationwide had a contract price that was higher than the home's appraised value.
Unfortunately, appraisal gaps can negatively impact homebuyers. In many cases, buyers are asked to bring more cash to the closing to "close the gap" between the appraised and contracted value. Additionally, lenders use the lower of the appraised and contracted values to determine the borrower's loan-to-value ratio. A loan-to-value ratio, or LTV, is the relative difference, expressed as a percentage, between the current value of the home and the loan amount. In other words, it's how much of a property a borrower owns versus how much of a property the bank still owns. An appraisal gap can increase a borrower's LTV making it necessary for them to pay mortgage insurance.
As a buyer or a seller, if you find yourself in a situation where you are facing an appraisal gap, lean on your real estate agent as your trusted advisor to help you determine the best course of action. Your agent can help you understand your best options and handle any additional negotiations needed.