The Role of Appraisals in Securing a Mortgage

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Appraisals are often a required part of a real estate transaction. They’re used to determine the fair market value of a property, which is an important factor in determining the price at which a property should be bought or sold. However, in some cases, the appraisal may come in lower than the agreed-upon purchase price, creating what is known as an appraisal gap. As a result, appraisal gap coverage can help protect buyers and sellers in a real estate transaction.

An appraisal is an assessment of a property's value by a licensed appraiser. The appraiser will consider a variety of factors when determining the property's value, including its location, condition, size, and recent sales of similar properties in the area. The appraisal is usually required by the lender to ensure that the property is worth the amount of money being loaned for the purchase. The buyer typically pays for an appraisal. Cash purchases do not require an appraisal because they do not involve a lender.

An appraisal gap occurs when the appraised value of a property is lower than the agreed-upon purchase price. For example, if a buyer agrees to purchase a property for $500,000, but the appraisal comes in at $450,000, there is an appraisal gap of $50,000. This creates a financial gap that needs to be covered for the seller to receive the price the buyer offered. There are a few different options to cover that gap — the seller can lower the price, the buyer and seller can meet in the middle, or the buyer can offer appraisal gap coverage.

Appraisal gap coverage can be written into the offer to protect buyers and sellers in the event of an appraisal gap. The buyer agrees to provide additional funds to cover the difference between the appraised value and the purchase price. The amount offered can change — they may set a limit (i.e. $25,000) or unlimited funds, which usually requires proof of funds to reassure the seller that they can cover the full gap. This can be especially helpful for in competitive markets. Buyers should be advised that appraisal gap coverage is not part of their mortgage payment and can typically expect to pay that cost as cash at closing. We always advise speaking to your lender to make sure you understand the financial obligation of appraisal gap coverage.

We can usually anticipate and prepare for an appraisal gap depending on market conditions, and we work to make sure our clients understand the appraisal process and the potential for appraisal gaps when buying or selling a property. Gap coverage can be a useful tool for submitting a competitive offer that will win the home.