What The Heck Is Appraisal Gap Coverage

Cash is king and any Agent, Buyer and Seller know that offering cash for a property will likely win you the contract. However, Agents and Buyers are getting savvy because not everyone has a stockpile of cash to pay for a home. There are other ways that buyers can win offers and some of the tactics can be confusing to understand, especially for a first time home buyer. In the next few blogs, we will go over some scenarios that may need to be employed for you to “win” an offer as the Buyer, and if you are the Seller, you will see how this works to your advantage.

Today let’s talk appraisal gap coverage. In a financing situation, the appraisal plays a huge part in the contract. The lender will require an appraisal, at the buyer’s expense, to ensure the money they are loaning out is worth the value of the home being purchased. This is part one part of satisfying the financing contingency of the contract. Again, if you are paying cash or accepting a cash offer, this will not be relevant.

Appraisal Gap Coverage – A Realtor’s job is to price the home where they know it will appraise using comparable sales in the area, assessing the upgrades and renovations to the home and the age of mechanicals/roof etc. As we all know in this market many buyers are offering over asking price. Section 3.2(d) of the Columbus Board of Realtors Purchase contract says that the buyer can terminate the contract, in writing, within 5 days of receiving an appraisal that falls short of the purchase price. So in a normal market if you have an appraisal that comes in short you can 1) pay the difference 2) negotiate a lower purchase price 3) terminate the contract. In this Seller’s market the Seller’s are not negotiating a lower sales price, Buyer’s are not terminating the contract. What we are seeing is that Buyer’s are writing in appraisal gap coverage language into their contract to essentially put their money where their mouth is. Think of it as an insurance policy to the Seller that they will get the amount offered regardless.

Appraisal Gap Coverage language is written into section 1.1, Additional Terms and Conditions of the Purchase Contract. This guarantees the Buyer will cover any shortage in appraisal at closing. The verbiage looks something like this; Should the property appraise for less than the final agreed upon purchase price (a “Short Appraisal), Buyer will cover any shortage of appraisal up to a maximum of $______. Final purchase price shall be agreed to in writing by Buyer and Seller. The buyer then can cover any amount between the listing price and offer price.

This can get tricky. If you are the Buyer, you want to make sure you have the funds to do that AND cover your down payment/closing costs. Your out of pocket closing expenses just increased that amount. If you are a Seller, you want to see that the Buyer’s lender verified funds for appraisal gap. This means that not only are they pre-qualified for the loan, they have enough cash reserves to pay an appraisal gap if necessary.

Keep in mind that if the property appraises for the offer price, the Buyer is safe and does not need to worry about the extra cash for closing. BUT, it may be a week or two before you know that. Here are a couple examples to help you understand the impact of the appraisal gap.

Example #1

Listing price $350,000
Buyer offers $360,000 with appraisal gap coverage for up to $10,000, Buyer plans to put 20% down.
Home appraises for $360,000, Buyer doesn’t have to bring any extra money to the closing table, they get a loan for $288,000, their downpayment is $72,000.
Appraisal Gap Language was insurance not needed for this scenario.

Example #2, same house:

Listing price $350,000
Buyer offers $360,000 with appraisal gap coverage for up to $10,000, Buyer plans to put 20% down.
Home is appraised for $350,000, Buyer is now responsible for the $70,000 down payment and an additional $10,000. The loan amount will be for $280,000, which is 80% of the appraised value. This does not include closing costs, so figure in an additional $3-5,000 for title and lender costs.

Example #3, same house:

Listing price is $350,000
Buyer offers $360,000 with appraisal gap coverage for up to $10,000, Buyer plans to put 20% down.
Home is appraised for $340,000, Buyer is now responsible to pay coverage up to $10,000 but the Seller will only get $350,000 as their purchase price, not $360,000. Since the Buyer only guaranteed $10,000 in gap coverage, Section 3.2(d) kicks back in. The Buyer can terminate the contract within 5 days, or ask the Seller to lower the price to $350,000. The Seller can decline the lower the price from your $360,000 offer, so the Buyer needs to either be willing to walk away or come up with an additional $10,000 adding to their the total cash out of pocket BEFORE down payment and closing costs.

Example #4, same house:

Listing price is $350,000
Buyer offers $360,000 with appraisal gap coverage for up to $10,000, Buyer plans to put 20% down.
Home is appraised for $355,000, meaning the Buyer only owes an additional $5,000 since they will be able to get a loan for 80% of $355,000 and they owe the Seller $360,000.
Appraisal gap coverage of $10,000 but only $5,000 was needed.

As you can see, one additional condition can have several outcomes. Make sure you understand what you are agreeing to prior to writing that in to your offer. Any appraisal gap coverage you offer could impact the amount of money you have available to make improvements or conduct yearly maintenance on your new home.

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