The Huge Homebuying Hurdle Nobody Is Talking About (and It’s Not a Down Payment)

published Jun 15, 2021
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As a first-time homebuyer who’s done your homework, you know that getting in the door requires some hefty savings: A down payment, closing costs, and even a sizable cushion left over after you close, for starters. But there’s another common cost — the appraisal gap — that, in some scenarios, may be the most expensive part of buying a home today. Appraisal gaps are a discouraging sign that today’s real estate market is too hot to handle for buyers who need financing. 

Here’s how this is playing out: Let’s say a home is listed for $350,000 and it’s receiving a lot of bids. To gain a competitive edge, you bid $400,000 for the home. (A record high of 50 percent of homes are going for over the asking price, according to a May 2021 report from Redfin). But, if you’re taking out a mortgage to buy a home, your lender will require an appraisal, which is an unbiased, professional opinion of what the home is actually worth, bidding frenzy aside. If the appraiser determines the home is worth only, say, $360,000, then you need to come up with enough cash to “close the appraisal gap,” which in this case would be $40,000. 

In these instances when a home doesn’t come in at the appraised price, you may be able to renegotiate with the seller, but in this hot market, there’s a glut of investors who will be able to buy the home with all cash (and, without any lenders involved in the transaction, they technically don’t even need an appraisal). Just so you know, the appraisal contingency clause in your contract is an important one, because it lets you back out of the deal if the home appraises for less than the purchase price.

Lenders like to see the mortgage loan value be less than the appraised value of the property, explains Steve Sexton, financial consultant and CEO of Sexton Advisory Group. A higher down payment to lower the loan amount could be one workaround, yet still requires shoring up more cash. 

So, what happens if you find yourself in this scenario? You could dispute the appraisal with your lender, says Dawn Pfaff, who has more than two decades of experience as an appraiser and is the president of My State MLS

“You’ll need to provide a compelling argument to support your dispute,” says Pfaff. “Your real estate agent can help you find comparable sales that support the valuation you are seeking.” 

One of the biggest factors that can affect your appraisal is the market adjustment for time, she says.

“If the original appraiser used a comparable sale from six months ago, but prices have been rapidly increasing in the area, the price would need to be adjusted for the current market,” Pfaff says.

Still, the appraisal could come back with the same price (or an even lower one) the second time around.

It’s an unfortunate spot to be in. Squeezed inventory and a new home construction slowdown during COVID-19 means there aren’t many homes on the market. Still, record-low interest rates have brought buyers out in droves. The result? Sellers are receiving multiple bids on their homes, and many are coming in over the list price — as in thousands and thousands of dollars over. 

Something to keep in mind in this lopsided market: There’s a difference between how much a home is actually worth (the market value) and the auction value (how much buyers are willing to pay), says Ryan Lundquist, a certified residential appraiser and housing market analyst in Sacramento. The appraiser acts as the “eyes of the lender,” he says. That’s because banks need to be sure that the loan they’re extending to you is justified by the property’s value; should you default, they’ll need to recoup the loss. 

Making up for the gap between the appraised value and the amount you’re willing to pay is no small feat. One thing is for sure: today’s market requires a lot of patience — and money.