What Happens When an Appraisal Comes in Low?
In today’s market, one of the biggest issues that continues to plague both buyers and sellers during escrow is the appraisal process. Home prices are rising so quickly, that it’s been a common problem that when the appraisal comes back, it often is lower than what the buyer has offered to pay. So what happens when the appraisal comes back below the price the home is in contract for? There are 4 main outcomes, so let’s take a look.
- The buyer will have to come up with the difference between the price they said they would pay in the contract and what the appraisal value comes back at because the lender will only approve a loan based on the appraisal price (there are some exceptions to this but we won’t go over those exceptions in detail today). So for example, if the buyer offers to pay $800,000 for a home but the appraiser says the home is only worth $780,000. The buyer would have to come up with $20,000 in cash to cover the difference in order to stay in escrow.
- The seller would have to agree to lower their price to the price it was appraised at. In today’s market, it’s possible for this to happen, but not very likely when the seller often has a few backup offers ready to go if the current buyer can’t find a way to cover the difference.
- The buyer and seller have a second round of home price negotiation and end up meeting somewhere in the middle. This is probably the most common way an appraisal issue is resolved during escrow right now and the person who ends up paying less of the difference is often the one that has the most leverage (we’ll get into leverage later).
- If there is significant and clear evidence that the appraiser did not perform the appraisal correctly, for example, they did not use the most recent and most accurate comparable sales when evaluating the property, then you can contest the appraisal, send in supporting evidence, and ask the company to reevaluate the property to try and get the appraisal changed to a higher amount. However, a word of caution, getting an appraiser to change their initial appraisal is extremely difficult and the evidence has to be overwhelming to really have the appraisal company take a second look at it. The overwhelming majority of contested appraisals never get changed.
If one of these four resolutions doesn’t work, and the buyer and seller can’t come to an agreement on how to solve the issue, escrow will be cancelled, as long as the buyer has their appraisal contingency in place, the buyer will get their initial deposit back and start the process of trying to find a home again, and the seller will then either need to put their home back on the market, or if they have a backup offer they can then go into contract with that buyer if they are still interested.
Escrow getting cancelled is obviously not what either the buyer or seller wants when they go under contract, so what can both buyers and sellers do to try and prevent issues with the appraisal leading to escrow being canceled? Let’s take a look at some strategies that when implemented correctly, will both protect buyers and sellers and at the same time give the transaction a better chance of success when these issues do arise.
- In a purchase contract you can pre-negotiate the max dollar amount you’ll pay over appraised value if it comes in low. This will not only give you a better chance at getting your offer accepted up front because you’re helping the seller mitigate some fear they might have about the appraisal process, but it also caps the amount of money you are on the hook for if it doesn’t come back at value so you aren’t just giving the seller a blank check for the difference (i.e. removing the appraisal contingency up front).
- Make sure your agent is asking the seller/seller’s agent why they are selling, if they are moving, and where they are in that process of moving. Then make sure your agent is asking for updates after you get into escrow so you know where the seller’s stand and what leverage you may or may not have when the time comes to get the appraisal back. If the seller is in escrow buying a place of their own, and they need to proceeds of the sale of their home to buy the new home, you will have significantly more leverage when negotiating if the appraisal doesn’t come back at value because if you and the seller can’t agree on what to do and escrow is cancelled, there is a high likelihood the sellers will also have to cancel escrow on the home they are trying to purchase themselves on the back end which is obviously something they don’t want to do. The farther the seller is in the process of buying their new home, the more leverage you will have for any negotiations during escrow.
- Know the comps and what the homes true market value should be before writing up your offer. You need to know what you are walking into and the risk involved before placing that offer. If you have a good grasp on what the homes true market value is, you’ll be able to have a better idea of the risks involved with not only placing an offer higher than market value, but how likely it will be that the appraisal doesn’t come back at that value and what the difference might be. This way you can structure your offer to keep yourself protected and generally know what to expect from the appraisal process so there are less surprises during escrow.
- Pre-negotiate the appraisal issue up front, if the buyers are not willing to take off the appraisal contingency all together, how much can you get them to commit to pay above the appraised value? The more security you can create around issues that might come up during the appraisal process, the less you will have to worry about what it comes back at. Also, remember if your buyer commits to paying up to $10,000 above appraised value if it comes in low and it actually comes in even lower, lets say $15,000 below, you can still ask the buyer to come up to cover the whole difference, they might not be willing to, but worth trying, if the buyer really likes it they might find a way to make it work.
- Give yourself the best shot at getting the property to appraise. The appraiser won’t spend a lot of time in the home, generally they just measure each room and snap a few pictures, but you want to make sure it’s clean, still shows well, you have some of the basic things done before they show up, like having the correct # of smoke/co2 detectors in the correct places based on fire code, and have your water heater property double strapped for earthquake safety. These are things appraisers are looking for during every visit so don’t give the appraiser any reason to not look favorably at your property.
- Make a list of all the recent upgrades you have done to your home that would increase the value of your home. These are things the appraiser might not see when at the home (they might not be visible like new AC ducting/ plumbing etc.) so you want to make sure you are able to point them out. This list, as well as the comparable sales you and your agent used to price your property should be handed to the appraiser when they show up at your home. They might not use all the info you give them but anything you can do to increased the perceived value of your property is worth trying. When you get multiple offers on your home that are close to, or even higher than, the offer you accepted, I also make it a point to show the appraiser that the buyer that is in escrow is not the only one willing to pay a premium for this home. Again, this just gives the appraiser more information to help them justify that the price you are in escrow for is the true market value of the home and your current buyer wasn’t just a diamond in the rough. There are people lining up behind them to buy the property at a similar price.
- Review the buyers financials when they submit an offer, specifically how much liquid funds they have in their accounts. When the housing market was normal, it was important to verify that the buyer at least had the funds in their account to cover the downpayment they said they were going to make as well as any closing costs. However, in today’s market you really want to see if the buyer has additional funds in their account to at least have the ability to come out of pocket to cover any difference in the appraisal, the higher the offer the more funds you want to see them have. I’ve had plenty of sellers go with a slightly lower offer because the buyer had more cash on hand to be able to cover any issues with appraisals that might arise. If you end up going with the highest offer but they can barely afford the downpayment and closing costs, you might be shooting yourself in the foot. If the home doesn’t appraise, there is nothing more the buyer can usually do and you’ll be faces with either coming down to the appraised value or canceling escrow and starting over again. Before accepting an offer, know what your home’s actual market value is (have comps and an agent you can trust), look at the offers you get, and make sure there are enough funds to cover the difference. This is one of the many vetting tools you should be using to decide which offer to accept.
- Try to find out why the buyer is purchasing your home, are they selling a home of their own, do they have deadlines where they need to be in a new property? The more they need to be in your home in a specific timeframe, the more leverage you might have if the appraisal doesn’t come back at value. WARNING, you need to be very careful asking for any personal information from potential buyers as fair housing laws in California are very strict and there are many different classes of people that are protected against any type of discrimination. It’s best to consult with your agent before trying to find out any info about your buyers, especially before you get into escrow.
As you can see, there are plenty of things on both the buyer and seller side that someone can do to help keep escrow running smoothly even if the appraisal doesn’t come back at value.
Buyers remember, your strategy for the appraisal will most likely vary from home to home so make sure you review all of your options each time with your agent before placing an offer.
Sellers, make sure you talk to your agent to get a good idea of what issues are popping up most often in today’s market when it comes to going through escrow and make sure you are negotiating your contracts to mitigate as much risk as possible when selecting a buyer. Remember, right now you have the majority of the leverage when negotiating the purchase contract so take advantage while you can!