What to do if the House You are Selling/Buying Doesn’t Appraise?

“I’m selling my home and I just found out the appraisal came in lower than our contract price. I had multiple offers and they all wanted to pay more than this appraised value. What do I do now?”

This happens more often than you might think.  Especially in an appreciating market with high demand for housing and competitive bidding. Meanwhile, the buyer is often wondering…

“The house I’m buying didn’t appraise for the sales price we agreed to. Do I have to pay the contracted price or can I renegotiate? What do I do now?

So why do properties fail to appraise and what can you do about it?

Consumer demand, the price that people are willing to offer and pay for a home, may be more than an appraiser can value a home. In making a loan to a borrower to purchase a home the lender is taking a risk. The appraisal is one tool the lender will use to help protect themselves against borrower default. One of the lender’s concerns is making a loan on a home that is selling for more than it is worth. In that instance, if the borrower walks away from the property the lender could be stuck with the property and lose money.

In making the loan the lender will rely on the opinion of an independent expert. That expert will base the appraisal on the condition of the property, the value of similar homes sold in the surrounding neighborhood, and a factor for market appreciation or depreciation.  However, the factor for appreciation or depreciation is based on historical averages and does not necessarily account for current market conditions.

This is the crux of the problem – market demand can outpace the value of past sales.

Regardless of market demand, the lender is relying on the appraised value to support the contract price.  If the appraised value is higher than or equal to the contract price, the lender is happy.  If the appraised value is less than the contract price, then there is a problem.  

The lender requires the loan and down payment to be based on the lesser of the contract price or appraised value. A borrower could still pay the negotiated price but the lender will base all loan amounts on the lower appraised value. This means that to move forward a borrower would have to pay the down payment based on the appraised value plus pay, out of pocket, the difference between the appraised value and the contract price.

Here’s an example.

A home is under contract for a sale price of $200,000, the buyer plans to put 20% down to avoid mortgage insurance but the home appraises at $190,000.

Sales price – $200,000

20% Down payment – $40,000

Home appraisal – $190,000

Based on the $190,000 appraisal the new 20% down payment would be $38,000. If the home price remains at $200,000 the buyer must pay the $38,000 plus the difference between the $200,000 sales price and the $190,000 appraised value, which is $10,000. So the borrower’s cost is now $38,000 (down payment) + $10,000 ($200,000 – $190,000) = $48,000!

Buyers sometimes will not or cannot pay the extra required out of pocket to cover the down payment plus the difference between the appraised value and the sales price. Nor are they generally required to do so.  Real estate purchase contracts usually contain an appraisal contingency to protect the borrower and the lender from this exact situation.

When a house doesn’t appraise for the sales price the buyer will usually show the low appraisal to the seller and begin to re-negotiate the price. This is where discussions can become tense. A seller often has a lot of history with a property and they may be viewing their home through rose colored glasses. The low appraisal may be difficult for them to agree with. They are also likely trying to get as much money from the sale as they can and may be hesitant to renegotiate.

In this situation, the seller may demand the original $200,000, accept the new $190,000 appraised value or ask for something in between. If the seller holds to the sales price there’s a risk the borrower walks away. That risk might be worth it if there multiple offers on the property and one of the other bidders is willing to pay the full asking price. But that’s a risk and not a guarantee. How many borrowers will be willing and able to pay more than the appraised value?

The borrower in this situation may demand the new $190,000 appraised value, pay the full sales price, or ask for something in between. If the borrower demands the new appraised value there’s a risk the seller refuses.

If the seller and the borrower cannot come to an agreement the buyer cancels the contract and the seller can go back on the market and hope for a better result.  However, the seller should be aware that if the low appraisal was an FHA or VA appraisal the appraisal will remain in the system for the next FHA or VA buyer. 

This is the situation my wife and I were in when we were purchasing our second home in 2009. The appraisal came back well below the sales price and when we shared that appraisal the seller was not happy. Fortunately, they were motivated. The housing market in Phoenix was in a terrible slump with no end in sight and there was little chance another buyer was going to pay the full asking price.

We were motivated too. We had been looking at homes in the neighborhood for more than 2 years and had been living in a two bedroom apartment for 15 months. The property ticked almost all the requirements we had identified and we could be moved into the home in time for our daughter to start kindergarten at the neighborhood school.

We offered to split the difference with the seller and they accepted. We could have held to the appraised value but the seller wasn’t in a position where they had to sell. They could have refused and waited for another buyer while we continued looking and living in a small apartment. In the end, it was in the best interest of both parties to come to an agreement and meet in the middle.

For more information contact Aaron Walker or Jay Rapson at Aaron Lending, LLC.