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What is an Appraisal Gap Waiver, and Should I Use One?

If you’re in the market to purchase a home, be prepared to face some challenges. One of the biggest hurdles you might encounter is an appraisal gap, which occurs when the appraised value of a home falls short of the contracted purchase price

Mortgage lenders require an appraisal to determine the fair market value of the property and the amount of your loan, and unfortunately, that doesn’t always align with the seller’s goals or the asking prices of comparable properties

In a typical mortgage contract, it’s common for hopeful home buyersto be protected by a contingency that states if the appraised value falls short of the agreed-upon price, they have the option to renegotiate the terms or even back out of the deal.

But in a competitive real estate market like present-day Chicagoland, this discrepancy can leave you short of the home value you based your down-payment upon. , All the while, other buyers are eagerly waiting to take your place.

These days, in a competitive offer situation, many agents are advising, or sellers are requiring an appraisal gap clause or waiver to even consider an offer. However, before going ahead, it’s important to understand what exactly an appraisal gap waiver is, how it works, and whether it’s the right choice for you.

Background and Definitions

Buying a house involves a variety of considerations, calculations, and acronyms, and determining the mortgage loan amount you qualify for depends on several factors. The appraised value of the home you want to purchase is a crucial element in the equation.

Essentially, an appraisal is an unbiased assessment of a property’s value. An independent third party will assess the home’s location, condition, and recent sales of similar homes in the area. 

In the Upper Midwest, some buyers are willing to pay more than the appraised value in order to secure their dream home. However, this can create a problem when it comes to financing, as lenders typically only provide loans based on the appraised value of the property.

An appraisal gap waiver makes your offer stronger which gives you leverage in a bidding war, but it also means you’ll be accepting the responsibility for buying a home that’s appraised value has come in short of the price you’re about to pay. An appraisal waiver can be open ended, or more effectively, can indicate the buyer is willing to accept any gap in value up to a specific limit. Having the waiver in writing protects the seller from wasted time, the buyer from overpaying too much, and ensures everyone is on the same page. 

These types of waivers have become increasingly popular in most urban real estate markets, where prices continue to rise. They can be a useful tool for buyers who are willing to pay top dollar to snag a house they’ve got their heart set on. However, it’s important to carefully consider the risks and potential drawbacks before pursuing this option.

Things to Consider

It is a very common misconception that a $10,000 gap in appraised value, for example, means that a buyer needs to bring an additional $10,000 to the closing table on top of what they’d originally planned. The reality is that the difference in value impacts an important ratio – the Loan-to-Value (LTV.) 

If your loan product requires you to put down 20%, but you’d planned to put down 25% of the home’s value, you may not have to change a thing. It is merely the case that the “value” part of the equation is simply lower than expected, and thus you’re putting down 22% or 23% of the home’s appraised value, and you don’t need to change a thing. 

On the other hand, if you were really reaching to put down 5% on the purchase of a home, as a repeat home buyer, and now that home is “worth” less, you may be required to bring additional funds to the table. 

A knowledgeable lender can help you to understand how this applies in your specific situation.

The biggest advantage of an appraisal gap waiver is that it can help you secure a home in a seller’s market, where competition can be downright fierce. It shows the seller that you’re willing to play ball, and this can make your offer more attractive than others, giving your offer a higher chance of being accepted.

But if you’re not well-informed, following this path can leave you underwater — owing more money on your mortgage than the value of your home. This creates negative equity and can make it difficult to sell or refinance.

If you find yourself unable to make your mortgage payments and the lender forecloses on the property, you’ll be responsible for paying the difference between what you owe and what the property is worth.

Another potential disadvantage of this contractual clause is that it can encourage a bidding war with other buyers and the price of the home can quickly escalate beyond what it’s actually worth. This can lead to paying more than you should and making an unwise investment you might regret.

That’s why working with a great broker and a knowledgeable mortgage lender is so critical. They’ll evaluate local real estate market conditions and advise you whether an appraisal gap clause is the right choice. In a highly competitive market with multiple offers on almost every property, it may be necessary, but in a slower market or in more rural locations, it’s probably avoidable.

It’s vital to carefully assess the property’s condition and value before going this route, and you should always get a home inspection. Is the property in good condition, or does it require extensive repairs? Is its value likely to increase or decrease in the future?

In certain circumstances, your broker may be able to negotiate with the seller to lower the purchase price. If the appraisal comes back significantly lower than the agreed-upon purchase price, it might be smarter to just walk away.

Talk to your lender and real estate team about exploring other financing options. Some lenders offer piggyback loans, where a second loan is taken out to cover the down payment or appraisal gap, avoiding the need to hunt for additional funds. 

Know Where You Stand

Before you sign on the dotted line no matter what the cost, it’s essential that you carefully consider your financial situation, local market conditions, and the property’s condition and true value. 

Appraisal gap waivers or clauses can help your offer rise above thick competition, but it also comes with risks. If you have doubts about the property’s value or foresee challenges in the future, it may be wiser to reconsider.
Consult with your real estate agent, mortgage lender, or financial advisor to gain insights tailored to your specific circumstances. We can provide the guidance you need to help you understand the potential risks and benefits associated with an appraisal gap waiver — give me a call today to learn more!

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