Appraisal Gap: Understanding, Managing, and Solutions

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• An appraisal gap occurs when a home appraises for less than the price you offered.
• Appraisal gaps can increase your out-of-pocket costs or even force you to back out of a purchase.
• Including an appraisal gap guarantee with your offer can help prevent losing a home due to appraisal issues.

A home appraisal is a standard part of the homebuying process. But if the appraised value of a house comes in lower than the price you offered for it, it can complicate things with your mortgage financing.

However, an appraisal gap doesn't necessarily mean you'll have to cancel the purchase. There are ways to work around it.

What is an appraisal gap?

Mortgage lenders won't lend you more money than a home is worth. So when you make an offer, your lender will order a home appraisal to verify its value. If the appraiser determines the property isn't worth what you've offered, you've got a problem.

"When an appraisal comes in low, there is what's referred to as an appraisal gap — or the difference between the agreed-upon purchase price and the appraised value," says Bill Gassett, a real estate agent with RE/MAX and founder of Maximum Real Estate Exposure . "When a buyer is not financially able to bridge the gap, the sale can fall through."

Fortunately, there are a few ways to keep the transaction alive — and even proactively prevent an appraisal gap from throwing off your purchase.

Important: If you're paying cash, you won't have to worry about appraisal gaps. Home appraisals are only required if you're financing a home purchase. You may still want to get one to ensure the house is worth the price, though.

How the home appraisal process works

Lenders order home appraisals to protect themselves if you default on your loan . For example, if you stopped making payments, they could foreclose, sell the property, and be more likely to raise enough cash to cover your overdue loan balance.

During the appraisal, a real estate professional will inspect the property and assess its current market value. To do this, they'll take into account the cost of rebuilding or replacing it, the value of recent comparable homes sold in the area, and any income-earning capabilities of the property. They will also usually conduct a physical evaluation of the home.

There are several reasons an appraisal might come in lower than what you've offered for it. Home values in the area may have declined recently, or the appraiser may have uncovered defects in the home or determined it needs improvements. There's also the chance you simply offered too much for the property, perhaps to beat out other buyers or win a bidding war .

As Gassett explains, "One of the downsides of a bidding war is the increased opportunity for a home not to appraise at the agreed-upon price."

Appraisal gap example

Here's how an appraisal gap could arise in a home purchase:

Let's say you offer $450,000 for a home. The seller accepts, and you start finalizing your mortgage with your lender. The lender sends out a professional appraiser, who determines the home is only worth $430,000 in the current market. That leaves you with a $20,000 appraisal gap to deal with ($450,000 to $430,000).

Causes of appraisal gaps

Appraisal gaps can occur for several reasons. These include:

Market conditions

Sometimes, if it's a hot housing market, sellers may be able to ask for a higher price than their home is worth. This drives up home prices and can make for more appraisal gaps.

Other market conditions can affect prices, too. If there are lots of foreclosures in the area, for example, it can lead to lower-than-expected appraised home values. This would also cause an appraisal gap.

Overpriced offers

When buyers make high offers, either to outbid other buyers or to ensure they get the home, it can often result in an appraisal gap. They'll need to be ready to cover the gap somehow if they want to go through with the transaction.

Inaccurate comparables

If there aren't enough comparable sales in the area, it can be hard for appraisers to assign an accurate value to a home. Inaccurate comps — ones that maybe sold for less than they should have for some reason — can throw a kink in things as well.

Implications of an appraisal gap

Lenders order home appraisals to protect themselves if you default on your loan . For example, if you stopped making payments, they could foreclose , sell the property, and be more likely to raise enough cash to cover your overdue loan balance.

If a home doesn't appraise to the offered value, it's a problem — for the lender, seller, and the buyer.

Impact of an appraisal gap on buyers

When there's an appraisal gap, buyers have a decision to make. They can either cover the difference between the appraised value and their offer out of pocket, renegotiate with the seller for a lower price, or pull out of the deal. Depending on how much cash you have, it could very well be a dealbreaker.

Impact of appraisal gap on sellers

Appraisal gaps can send sellers back to square one, if it causes their buyer to back out of the transaction. This would mean re-listing the home, remarketing it, and waiting much longer to close (and get the proceeds for the home).

Impact of appraisal gap on lenders

Lenders will only loan you what the home is worth, minus your down payment, so if your appraisal comes in low, there's not much lenders can do. In the event the buyer tries to dispute the original appraiser or have a new one done, the lender may have to underwrite the loan again, delaying the purchase.

Strategies to manage and bridge an appraisal gap

Have you come up against an appraisal gap in your home purchase? Try one of these strategies for managing appraisal gaps:

Negotiate the purchase price

You can attempt to negotiate with the seller and ask them to accept the lower appraised value for the home instead of your original offer. You might also consider asking them to meet you somewhere in the middle, with you covering a portion of the appraisal gap and the seller also accepting a slightly lower price than your original offer.

Increase the down payment

Increasing your down payment can also help. This is essentially just paying for the difference between the appraised value and your offer out of pocket. You'll pay this extra amount at closing.

Add appraisal gap coverage

Including an appraisal gap guarantee — also called an appraisal gap clause — in your offer can prevent appraisal problems from throwing off your purchase. They can also give you a leg up when making offers on properties.

"It puts in writing a buyer's intention to cover the difference between the purchase offer and the figure calculated by the appraiser, up to a certain amount," says Tabitha Mazzara, director of operations at mortgage lender MBANC . "It's the buyer's promise that if the appraisal comes up lower than their offer, they'll submit cash to the seller to cover the funds greater than the amount the mortgage company would lend on the property."

Sellers like appraisal gap guarantees because they reduce the risk of an offer falling through due to appraisal problems. As a homebuyer, you might include an appraisal gap guarantee to give sellers more confidence in your offer or help it stand out from other buyers. On the downside, though, it does mean you could potentially be on the hook for more out-of-pocket costs if the appraisal comes in low.

"In a hot real estate market where bidding wars are common, a buyer with an appraisal gap guarantee written into the offer will look more attractive to the seller than one without that flexibility," Mazzara says. "It might mean the difference between getting the house or not."

Legal and financial considerations

If you're buying a home, it's important to protect yourself both legally and financially. To do this, you'll need to understand:

Contingency clauses

Contingency clauses allow you to back out of the deal without losing your earnest money deposit, and there's one specifically for appraisal gaps. It's called the appraisal contingency, and it lets you either renegotiate or leave the transaction if the appraisal comes in low. Adding this clause is critical in a hot market and especially if you find yourself in a bidding war. Talk to your agent if you want to include this in your offers.

Appraisal gap FAQs

What is an appraisal gap?

An appraisal gap occurs when the appraised value of a property is lower than the agreed-upon purchase price.

Why does an appraisal gap happen?

Appraisal gaps can occur due to market conditions, overpriced offers, or inaccurate comparables used in the appraisal. Bidding wars can also cause appraisal gaps.

How does an appraisal gap affect buyers?

Buyers may need to bring additional funds to the closing table or renegotiate the purchase price if there's an appraisal gap. There are other strategies for appraisal gaps, too, like protesting the appraisal or getting a second opinion.

What can sellers do if there's an appraisal gap?

Sellers can consider lowering the sale price, requesting a reappraisal, or exploring other buyers who may accept the appraised value. Most appraisal gap solutions target the buyer, not the seller.

What is appraisal gap coverage?

Appraisal gap coverage is a guarantee included in your loan contract that you will cover any difference between the appraised value and the purchase price.

How do you go about negotiating an appraisal gap?

If you're facing an appraisal gap, you can try to renegotiate your loan terms with the seller and ask them to accept a lower price. If they won't you'll need to pay out of pocket or back out of the deal.