Real estate agents nowadays are asking home buyers a new question: “Do you have appraisal gap money?” What is appraisal gap money, and do you need it?
The Latest Home Buying Trend: Appraisal Gap Money
Let’s follow a newly married couple as they look to purchase their first home. Over the years, they have each taken care to pay their bills on time and use credit cards sparingly, following good advice handed down to them by their parents. Happily, they have saved enough for a respectable down payment plus a little extra for closing costs and other expenses such as homeowner’s insurance. After buying their new home, they will have a modest amount left for new furnishings. They have been pre-qualified by a trusted mortgage loan officer and excitedly share their pre-qualification letter with their real estate agent in anticipation of beginning their home search. Before showing any homes, their real estate agent forewarns them it is a seller’s market. Many homebuyers are paying $5,000, $10,000, and some as high as $50,000 above asking price! Even though the newly married couple are strong home buyers in the traditional sense, the agent asks if they have any “appraisal gap money” as they will likely need to indicate that in their written offer.
What is appraisal gap money?
Appraisal gap money is money home buyers spend to cover the difference between an agreed-upon sales price of a home and the home’s presumably lower appraised value. This is in addition to any down payment, closing costs, and other expenses involved in buying a new home.
Let’s pick up where we left off with our newly married couple. After weeks of searching, they are beginning to feel hopeless. Finding a home in their price range has been a real challenge. There are only a few potential homes fthey can afford. Each time they have placed an offer, their offer has been declined in favor of multiple offers above asking price. When a new listing hits the market that would meet their needs, their real estate agent encourages them to act quickly. The seller is asking $225,000 – a fair price given recent sales in the area. The couple is worried about losing yet another home. In a moment of desperation, they ask their parents for help. Moved by the struggle this couple has been facing, both sets of parents agree to pitch in and give them a total of $10,000 as a gift. The couple calls their agent with the news they now have an extra $10,000 to go towards the transaction. They intend to use this as their “appraisal gap money.” They want to place an offer for $10,000 above asking price at $235,000 and if the home does not appraise for that amount, they can cover the difference with the gifted funds from their parents.
Do you need appraisal gap money?
If you are facing a situation as described above, you may need to build appraisal gap money into your home buying budget.
Generally speaking, when a home does not appraise for the agreed-upon sales price, there are three or four options:
- Buyer and seller mutually agree to release one another from the sales contract;
- Seller reduces the sales price of the home to match its appraised value;
- Buyer agrees to pay the difference between the sales price and appraised value (i.e. appraisal gap money); or
- Some combination of a) a reduction in sales price on behalf of the seller and b) the buyer paying the difference between the lowered sales price and appraised value (i.e. appraisal gap money).
However, there is another alternative…
Distressed Homes & Appraisal Gap Money
While our newly married couple is fighting the bidding war so common for home buyers today, their friends across town have decided to purchase an older home that has been on the market for a few weeks with few interested buyers.
The home they are buying is an old craftsman bungalow with built-ins and charm you simply cannot find in more recently built homes. A few concerns show up on the home inspection report, including knob and tube wiring, a plumbing leak, and decaying mortar on the brick porch. The new homeowners elect to build the costs for these repairs into their new mortgage, and they add a few other home improvements to their punch list. They have selected quartz countertops and subway tile backsplash to be installed in the kitchen for a cleaner, more updated look. The main bathroom will undergo moderate remodeling as well, and the buyers are excited to pick out their own finishes. They will also have the windows replaced, a new back door installed, and give the exterior a fresh new look by replacing the glass enclosure on the brick porch with pillars. Their contractor’s bid comes in at less than $40,000. The seller has accepted an offer of $135,000 and the buyers have planned to put down the minimum required for their renovation loan. When the appraisal comes in at $213,000, they are ecstatic over huge equity gain they will realize once the repairs have been completed.
Both couples qualify for a loan with the same down payment requirement and the same interest rate. One couple is fighting a bidding war and placing an offer above asking price on their new home while the other will walk away with nearly a 20% equity position once their home improvements have been completed. Which would you rather be?
Jennifer Goldsby, NMLS #591226 | VP, Renovation Lending
Diamond Residential Mortgage Corporation NMLS #186805 | Equal Housing Opportunity
Disclaimer: The postings here reflect my personal opinion. They do not necessarily represent the opinions of Diamond Residential Mortgage Corporation and its management.
