All right.
You've likely heard of an appraisal gap and wondered, is this something
that I should do should add to my contract, or maybe you've heard the
term appraisal waiver and wondered how this is going to affect you.
If you either have one or go up against other buyers who are using appraisal
waivers or appraisal gap clauses.
So I'm going to explain it in this video, how it works, if you should
use one and how it impacts kind of the whole home buying situation
and market that we're in right now.
Basically, let's talk about an appraisal first and appraisal is when
a lender, they need to justify the value of the home that you're buying.
So let's say we're looking at buying home for $425,000.
They're going to send an appraiser most of the time, they're going to
send an appraiser out to see if the home is worth that. They need to
justify that if they're going to give you a loan for close to $425,000
at the home is actually worth that.
If you end up not paying back the loan and they need to sell it.
So, what ends up happening is sometimes appraisals can come in low, and this is
often referred to as a short appraisal.
When that happens, it usually can kill the deal, because you said you were
going to offer the seller 425, but then the lender won't give you money
to be able to cover up to 425,000.
If the appraised value comes in at let's say $415,000, that's $10,000 sort.
So what happens with an appraisal gap, or an appraisal gap clause.
Sometimes people call it an appraisal waiver.
It's not an appraisal waiver.
We're not waiving the appraisal or waiving the appraisal contingency.
So often in something like a purchase contract, there is a clause that states,
if the home doesn't appraise that the buyer is able to back out of the contract.
Meaning that if the home comes in at a lower appraised value, you don't
have to continue moving forward.
Buying the house that gives you protection as a buyer.
In a really competitive market, having an appraisal gap clause or what
people would call appraisal waiver.
We're really just waiving the appraisal contingency.
It's called different things and it's confusing.
But what this does is it gives a little bit of incentive to the seller to
say, oh, we might go with their offer instead because they're willing to
pay extra money if the home doesn't appraise at the purchase price.
And so in this, you're basically saying we'll pay extra money upfront on top
of your down payment and closing costs to be able to move forward with this.
So for instance, you might have a real estate contract that you offer.
So when you give an offer to a seller, you find a house that you like and say, we
want to offer $425,000, and then you might
add a gap.
Okay.
And so for instance, you could add a $15,000 gap, or you
could add a 10,001 or a 5,000.
Basically what this means is if the home comes in, let's say $15,000
short in value, you're willing to bring $15,000 in cash to cover it.
So for instance, on a $425,000 purchase price here, you'd be
covering the difference if it came down to $410,000, okay.
Now you might ask, how can I compete against something like this?
If someone puts in an offer like this, you might.
At the point where you're like, you know, the down payment closing costs
are kind of really tight for us.
So we don't really have extra money.
And that is why people use these appraisal gap clauses is because
it helps their offer stand out amongst all the other offers.
This is a way to make your offer more competitive.
If you have the flexibility with cash, unfortunately it does make home buying
more difficult for people who don't have the cash to be able to spend like this.
So let's look at an example here.
So, the clause that gets written is going to be different based on your location.
All contracts are different locally.
Okay.
But this is just an example of what this could look like.
It might be included in your contract, or it may need to be a
separate addendum, with the contract.
So it might say if the property does not appraise for the purchase
price, the buyer agrees to pay up to $20,000 above the appraised value.
Not to exceed the purchase price.
So something that simple that basically says if the home value comes in 20,000
lower at the appraisal, you as the buyer, willing to pay $20,000 at the
closing table to make up the difference.
Okay.
So let's talk about really quickly the solutions to short appraisal, because it's
not just the appraisal gap that can help you with a short appraisal and shorter
appraisals, unfortunately are getting more and more common as home values
are well, as people are offering more for homes and home values do increase.
People are offering more a lot of times then a home is
worth in its appraised value.
Okay.
And they're putting in these appraisal gaps, so they might
get a short appraisal coming in.
Here's some solutions to fix this number one is we can ask
the appraiser to reconsider the value with new comparable homes.
When you get an appraisal, the appraiser is often looking at three
homes that have a recently sold.
Within the past six months and half mile radius.
That is that usually what they're looking at.
Your realtors, either the buyer, your agent or the seller's agent could submit
new comparables for the appraiser to use.
I haven't seen this be super successful as a strategy.
Another option is you could get a new appraisal.
This only works on a conventional loan, but you could actually switch lenders
and get a new appraisal with that lender.
And you're kind of hoping that the value comes in.
It could come in.
So just keep that in mind.
Option three is the seller reduces the price.
So, you know, back to our original example, if you offered 425 and it
came in at 415, the seller could drop the price to 415, odds are, they
probably don't want to do that. Fourth the option is you pay the difference.
You bring cash to the closing table to pay the difference here.
And this is what an appraisal gap clause is.
Okay.
It's basically building in this number four solution into the
contract before the appraisal happens.
All these other solutions happen.
If the appraisal comes in short.
Option, number four is what people use.
They kind of bake it into the contract to make their offer stick out.
Number five is basically splitting the difference.
Some people do this 50/50, even you might do 60/40, 80/20, whatever the
seller might come down a little bit.
And you as the buyer might bring extra money to the table.
One quick note here is you actually can use your down payment to
help cover a short appraisal.
So if you have a down payment that's higher than the minimum down payment,
for instance, on a conventional loan, the minimum is 3% down.
If you're putting 10% down, we have 7% of wiggle room there.
Where you can actually bring your down payment down to the minimum and use
that extra percentage to cover the short appraisal that sometimes can work.
Sometimes you can also remove seller credits to help cover
that difference as well.
So several different options.
You can talk with your loan officer to explore these options too.
And if you're looking for a helpful loan officer, I can give you an introduction.
I have a link down in the description.
If you are interested in that.
So next question is, will lenders allow this?
Because I know this can be kind of confusing where it's
like, why can't the lender?
Just give me the money that I need.
Lenders are going to look at lesser.
Of the purchase price or the appraised value.
They're going to look at the two and see which one is the lower one.
And they're going to use that as the actual value of the home and keep in mind
the reason why they're doing this is if you know, the lenders are looking at risk.
So if in the future.
You don't pay on the loan anymore and they need to foreclose and sell the home.
They want to make sure it's actually worth enough to cover
the loan that they gave you.
If they gave you a loan for up to 425,000, but it's only worth 415.
Then they took a loss on that there.
So they don't really want that to happen.
So they're gonna look at the lower of these two.
So in this instance, they're going to look at the 415, if the appraised
value is lower than the purchase price.
So then your down payment is going to be based on the lower value.
So if you were initially putting 5% down and initially you were going to be
putting 5% down on the purchase price, well, the appraised value came in lower.
So 5% down is actually going to be based on the appraised value.
So on a $415,000 appraised value, the down payment is $20,750.
So that sounds great.
Well, our down payment went down.
That's awesome.
But we still have to make up this difference because we're under
contract to purchase for 425, but the appraised value is only 415.
So the lender's loan, plus our down payment equals 415.
We can give that to the seller, but the seller still needs the 425.
And that's where we go back to the solutions that can help us resolve
these here with the appraisal.
Builds in this number four option to say we're actually going to cover that gap up
to a certain amount if it comes in shore.
Okay.
So keep in mind, this obviously is going to cost money to put in an appraisal gap.
So a normal appraisal contingency gives you as the buyer in option out of the
contract, where if you say, I want to buy the home for 425, but it appraises at 415.
You can back out of the contract.
That's what a normal appraisal contingency does.
It provides protection for you as the buyer.
If the value is shorter or is lower than what you initially
were going to offer for it.
So this is a nice built-in protection to help you not overpay for home.
Most people need this protection.
That's why it's baked into every contract that I've seen has this
clause, this contingency in there to protect you as the buyer.
However, an appraisal gap overrides that protection and then guarantees the seller
that it gets paid at the purchase price.
And you know, this is like up to a specific amount, right?
It's not an unlimited thing it's up to, and you can specify this
$20,000, $25,000, $3,000, whatever gap you want to put in there.
Obviously the bigger, the number, the more competitive your offer is.
Okay.
So just as a quick example, using the numbers we've been using, if
we have a 425,000 purchase price.
Let's say it appraises $10,000 short 415, our down payment is based on the 5,000.
I'm sorry, 5% down, which is $20,750.
Now that's not the end of the story.
We also have to pay the gap.
And let's say in this instance, we offered up to a $15,000 gap.
But the difference is only $10,000.
We're just going to have to bring the $10,000 to closing.
So at the closing table, you're going to be paying the down payment 20,750.
Any closing costs that you have as well.
And the appraisal gap difference that is only if you have that appraisal
gap clause in your initial contract.
So just be extremely careful that if you do decide to go forward with this, you
have the money to be able to do this.
You have the flexibility to be able to do this, and you're
comfortable spending that money.
If you need to.
So here's how to add this gap to your offer.
You want to set aside these funds before please do this before you
make your offer and be really comfortable with this decision.
Knowing that if you offer a gap for $15,000, you could have to
pay an extra $15,000 at closing.
Okay.
My friend, Javier Vidana it has a YouTube channel, which is fantastic, and
you should go watch it and check it out.
He calls his clutch funds and I just think it's a really great word for it.
Clutch funds are kind of these funds that you have that help sweeten
your offer a little bit to make it more appealing to a seller, to
choose your offer over other offers.
And your agent can help you explore what about you need here in the gap?
And if you're looking for a helpful agent, I can also make an introduction
to an agent link is in the description.
If you'd like that.
Now keep in mind again, you have the down payment, you have closing costs.
If you're offering a gap, make sure you're budgeting that too, but then
don't forget things like your moving expenses and everything that's going
to happen between now and you moving into a home, make sure that you're
extremely comfortable with this here.
Because the appraisal gap clause or this appraisal waiver has people
tend to call it is not for everyone.
And a quick side note, there are appraisal waivers were an appraisal.
Actually doesn't have to happen on a home based on what the
underwriting software says.
For some reason there's been this mix up where everyone calls appraisal
contingency waivers, appraisal waivers.
And they're not the same thing.
So just keep that mind when people are saying appraisal waivers and
appraisal is likely, still getting done.
They're just waving the contingency, usually up to a specified amount.
Okay.
To add this to your offer, you're going to include the appraisal gap
language in your purchase offer.
Again, this may be included in your contract.
There may be a line in there for that often.
It's usually an addendum that your real estate agent is going to have
to write and submit with your offer.
So talk to your agent and please, please make sure you're certain about doing this.
This is a really great strategy.
If you have the cash to be able to do this, most people need the protection
of the appraisal contingency.
And at the same time that appraisal contingency protection can make
your offer at less attractive in a multiple offer situation where
the home that you're looking at is getting multiple offers on it.
Okay. Just please be careful.
Talk with your agent.
Really work these numbers and say if we had to go, you know,
think plan, worst case scenario.
If we have to use all of that money make sure that you're comfortable with them.
Well, number one, obviously they can help you win a bidding war.
If you're looking at a home and it's getting 10 offers on it.
If the seller looks at your offer and they see, oh, great.
If the appraisal comes in short, they're willing to pay an extra $10,000 to
make sure that we have that protection.
You're basically adding a protection for the seller to
make your offer more attractive.
That obviously is going to help you win bidding wars, protects
you as a built-in protection right away from a short appraisal.
What often happens if you don't have an appraisal gap, is if a shorter
appraisal comes in it then is kind of your offer is up in the air.
Not only can you back out, but the solution on what to do next is kind of
up in the air and has to be dealt with.
So it adds an extra layer of protection in the beginning.
Obviously the big downside is you have to come up with extra cash.
You have to have the extra cash to be able to afford doing this in
a way you're taking a risk on we might not have to use it at all.
We might have to use some of it, or we might have to use all of it.
And the big risk here is this risk of being underwater and your
mortgage and being underwater is basically when the value of your
home is less than what you paid for.
Okay.
So I made this quick little illustration here to show right here.
This is what you, the purchase price that you would have paid.
And this theoretically is the value and the value could go up.
But when we're planning longterm, it's always helpful to look at both
solutions planning for things to go up is always great because the numbers
usually always work in our favor.
But if we plan for things to go down and we're comfortable with what that
looks like or where we are mindful of what the negative options look like.
It's a much better way to plan things in the future.
So if that's the case, if you made this little gap payment here, keep
in mind the value of your home.
Could trend downwards and that could bring you into more of a gap here.
Now, what does that ultimately mean?
Ultimately means it's going to be more difficult to sell your home in the future.
If you sell your home in the future, you might need to bring money to
close, or you might get less money than you expected in the beginning.
That is a possibility that you want to be mindful of.
Not a guarantee that the value is going to go down.
There are plenty of people especially in the past couple of years who have
put appraisal gaps or they have paid over what a home is theoretically worth
to an appraisal, and they have ended up making tens of thousands of dollars in
equity and appreciation on their home.
Just be mindful of what could happen.
Okay.
So some quick scenarios here, let's say we had a purchase price of 425
and we have a $5,000 appraisal gap.
So owner run through a couple different scenarios with appraisals
to show you how this works.
Let's say that the appraisal comes in higher than the purchase price.
And it comes in at $430,000.
This is the ideal situation.
Theoretically you've got a $5,000 discount for the home.
The appraisal is saying the home is worth 430 and you bought it for 425.
You got a nice discount.
You never had to bring it any more, extra money to the closing table.
If it comes in at the contract price.
This is great, too.
Nothing happens that gap of money is not being used at all.
And a quick aside too, like when you put in an offer with an appraisal gap clause,
you don't submit the money anywhere.
That is just saying, if appraisal comes in short, I'll bring extra
money to the closing table.
That money doesn't have to be held by anyone, or anything like that.
Now let's talk about these scenarios.
If the appraisal comes in short, let's say it comes in at $422,500.
If that's the case, then we have to use $2,500 of it.
See how we're saying up to $5,000.
Okay.
If it comes in at 420, we have to use the full thing.
We have to use the full $5,000.
So basically we're using the lender's loan plus our down payment,
plus the 5,000, taking all that.
And that's what we give to the seller.
And when I say we, I mean the title company is going to do that for you, but
this is kind of more theoretical here.
If it comes in at 410, let's say it comes in super low,
and it's beyond what you said you would cover in your appraisal gap.
Then this is that contingency kicks in where you actually have that protection
again. You said you'd only cover up to 5,000, but it came
in a lot shorter than that.
And if that's the case, you have the option to back out of
the deal, or circle back to the options to fix a low appraisal.
Maybe we look at submitting new comparables.
Maybe we look at getting a new appraisal, or we look at the other options we can
use to solve the short appraisal here.
Now, if you want to dig more into how to fix a shorter appraisal, to
be mindful of what you could run into and what you need to do in the future.
Look at this video right over here.