Before listing a home and entering into a purchase agreement, it’s crucial for sellers to prepare their property for an appraisal to avoid a low appraisal value. Including appraisal gap coverage language in the purchase agreement can help prevent panic, stress, and potential sale collapse.
An appraisal gap is the difference between the fair market value determined by an appraiser and the amount the buyer agreed to pay for the home. In a seller’s market, the scarcity of available homes frequently results in multiple offers and contract prices well above the listing price. For instance, if the buyer and seller settle on a purchase price of $375,000, but the property is appraised at $350,000, this results in an appraisal gap. Including appraisal gap language in negotiations ensures that terms won’t need to be renegotiated if the appraised value is lower than expected.
Beginning August 17, 2024, as a result of several National Association of Realtors (NAR) lawsuits, buyers collaborating with a Realtor must sign a Buyer Representation Agreement, which outlines the payment for the agent’s services. Governor Dewine has enacted HB466 into law, effective October 24, 2024, mandating that all Buyer Agents have a Buyer Representation Agreement in place when assisting buyers in purchasing residential real estate and multi-family units up to four units.
If the buyer asks for contributions towards prepaids, points, closing costs, or buyer-paid commissions, sellers should ensure that appraisal gap language is included in the purchase contract. Without this, the seller might find themselves at a disadvantage if the appraisal comes in low, as they would still be responsible for covering all the buyer’s expenses agreed upon in the contract.
A low appraisal doesn’t necessarily mean the sale must be canceled. The first step is to dispute the appraisal, as appraisers can make mistakes. Providing the appraiser with data to support the dispute can remedy some oversights. Unfortunately, some appraisals fall short due to appraisal bias based on racial disparity.
Real estate professionals have long advised sellers to neutralize and depersonalize their homes to help buyers envision themselves living there. Sadly, this may also be necessary to avoid racial bias in appraised values. Research shows a disparity range of 10% to 56% in Ohio. This unethical behavior by some appraisers has led Fannie Mae to conduct a study and establish guidelines for appraising appraisers.
If the appraisal remains low after disputing it, buyers and sellers have several options:
- Agree to split the difference equally or with a variable.
- The buyer can bring the entire difference to closing.
- The seller can reduce the price to match the appraised value.
- Both parties can agree to terminate the contract.
In some cases, when parties couldn’t agree or funds weren’t available to bridge the gap, the buyer agent (or listing agent in a full-service listing) reduced their commissions to save the deal.
Appraisal gap language can include specific terms in the purchase contract, such as:
- The buyer waives the appraisal entirely.
- The buyer agrees to bring the difference to closing regardless of the appraised value.
- The buyer agrees to bring a fixed dollar amount above the appraised value, not exceeding the contract price.
- Additional language stating that concessions up to the appraisal shortage amount are automatically removed.
- Additional language stating that other negotiated items, such as a home warranty, are automatically removed in the event of a low appraisal.
When negotiating an appraisal gap, it’s essential for the seller to verify that the buyer has the funds to cover the agreed-upon gap. Failing to verify funds can result in deals falling through if the appraisal gap cannot be covered.
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