How Does Appraisal Gap Coverage Work When Buying a Home?

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When buying a home, things don’t always go according to plan. Sometimes, your bank’s appraisal of a house comes up lower than your offer or even the seller’s asking price. If so, do you just walk away from your dream house?

An appraisal gap coverage will help you seal the deal on your dream house in such a situation. Let’s take a look at the meaning and usage of appraisal gap coverage.

The Basics: Appraisals And Offers

An appraisal is an estimation of a home’s value in the current market. Mortgage lenders carry out an appraisal by a licensed real estate appraiser to ensure that the buyer doesn’t overpay for a property. It also guarantees that they’ll be able to sell the property for the same value should you fail to pay the mortgage.

In a competitive market, buyers may offer a higher value than the selling price to get their offer accepted. Sometimes the appraisal value comes up lower than the buyer’s offer, and sometimes even the seller’s price.

Sometimes, sellers don’t do the things they should do to prepare for the real estate appraisal, which can influence how the appraiser perceives the property.

The appraisal gap coverage could be your saving grace when this happens.

What is Appraisal Gap Coverage

Appraisal Gap Coverage: Explained

The scenario for buying a house is pretty much identical. You find a home that you like, and you negotiate the price. If the property is in high demand, you may offer a higher price than the asking price.

The seller accepts your offer, and then you apply for a mortgage. The mortgage lender then goes to appraise the property. If all goes well, the appraisal and your offer match. But rarely does that happen.

When the appraised value is lower than your offer, the seller and buyer have a few options:

Option A: the buyer convinces the seller to accept the appraised price.

Option B: the buyer covers the gap between the appraised price and their offer.

If neither A or B is possible, the deal will fall apart. However, there is another option—an appraisal gap coverage.

The appraisal gap coverage is the buyer’s assurance to the seller that they will cover a certain amount of the gap between the appraisal and the offer.

For example, if a house is listed at $300,000, the buyer may offer $310,000 with a $5,000 appraisal gap coverage. Then, the property is appraised at $305,000. The appraisal gap coverage then kicks in, so the buyer has to come up with $5,000 in cash to meet the offer price.

What If Your Appraisal Gap Coverage Still Doesn’t Meet The Offer Price?

What happens if the appraisal gap coverage still comes up short of your offer? For example, if you offered to buy a $300,000 at $315,000 with a coverage of $5,000, that is then appraised at $305,000.

With your coverage, the purchase price becomes $310,000. Although the total sale price is lower than your offer, it is still higher than the seller’s asking price.

So, they will still likely agree with this price. Additionally, you get to buy the house at a lower price than you originally intended. So, overall, it is a win-win situation. Thus, you can still push through with the sale.

Why Do You Need Appraisal Gap Coverage?

An appraisal gap coverage gives you an advantage over other buyers. Even if you offer to buy a house way over the asking price, it provides your offer substance through the insurance to cover the gap between the appraised value and your offer.

Including this with your offer makes the seller more likely to accept your offer over, for example, an equal offer without an appraisal gap coverage. This is because, with an appraisal gap coverage, the buyer is less likely to walk away from the deal regardless of the house’s appraised value.

Thus, it guarantees the buyer that they will pay for the property at a higher value than the asking price. Simultaneously, it reduces the chance of deals not pulling through.

How Does An Appraisal Gap Coverage Work With An Offer?

After the seller accepts your offer, you need to put your agreement in writing. This is when you will need to contact a real estate attorney to draw up a real estate sales contract or to review the one provided by the seller. The agreement will state the agreed-upon price, the appraisal gap coverage, and other essential terms of the sale.

Usually, when writing the appraisal gap coverage into the sales contract, you specify a fixed amount that you are willing to cover. Your contract should never state that you will cover an unlimited amount between the offer and the appraised value.

The contract should also state that the appraisal gap coverage should not exceed the agreed-upon amount. So, for example, if the appraised value is at $307,000 and you offered to pay $310,000 with an appraisal gap coverage of $5,000, you will only cover the remaining $3,000.

In any case, the appraisal gap coverage puts you at an advantage as a buyer because it guarantees a win-win situation for both you and the seller.

There are several instances where the explained scenario may not necessarily play out as simply as described. An example might be when the property to be purchased is being done under the auspices of a legal entity like an LLC or corporation or other such business entities, especially those with multiple owners.

In such circumstances, there may, for instance, be specific provisions contained within the operating agreement or bylaws of the entity that stipulates how or what may or may not be permitted in the acquisition of a new property or asset.

When such is the case, it is usually a good idea to ensure that the operating agreement is reviewed by an experienced business attorney to ensure that your appraisal gap offer or the contract you enter into with the seller does not violate any terms contained within.

About the author: The above article on the appraisal gap coverage was written by Kanayo Okwuraiwe. Kanayo Okwuraiwe is a startup founder, an incurable entrepreneur, and a digital marketing professional. He is also the founder of a digital marketing company called Telligent Marketing LLC that provides attorney SEO services to help lawyers grow their law practices.