In this article:
The process of selling or buying a home is a bit like dating, and both parties need to spend time searching for the right fit — and must compromise at times.
Compromise may need to come into play if a house’s appraised value vs. the listed sale price is off base. The appraised value of a home doesn’t always match the sales price — and when the appraised value is lower than the sales price, this causes a significant financial problem for the buyer.
When the appraisal comes back for more or less than both parties expected, what happens? Let’s take a closer look.
A refresher: What is an appraisal?
The appraisal process involves hiring a professional appraiser to estimate a property’s fair market value. They take the location of the property, its condition, and recent sales of similar homes in the area into consideration to determine the home's market value. An appraisal reveals how much a property is “worth.”
Homebuyers use appraisals to help secure a mortgage loan, as the lender bases how much they will lend the buyer (or homeowner, in the event of a refinance) based on the market value determined by the appraisal.
Why would the appraisal price differ from the asking price?
Potential buyers don’t book an appraisal for the home they want to buy until a seller accepts their offer and they apply for a mortgage. Lenders require an appraisal to issue a mortgage loan, but you can choose to skip the appraisal if you pay in cash. The seller’s final sale price may be different from what the market value determined by the appraiser ends up being.
It’s best for both parties if the appraised value ends up being similar to the price negotiated by the buyer when they made their offer. If the post-appraisal market value is lower than the price the buyer agreed to pay, the buyer won’t be able to secure a mortgage, as the lender won’t agree to lend them more than what the appraiser says the home is worth. We’ll dive a bit deeper on this shortly.
This will lead the buyer to negotiate a lower sales price or they may choose to back out of the sale, which results in a lot of disappointment and wasted time on both sides.
Remember: Appraisals aren’t the same as home inspections. An appraiser evaluates a home’s value, whereas a home inspector makes a detailed report of the wear and tear on a home and any damage or hazards. In preparation for an appraisal, there are a few things a seller can do to avoid a reduced appraisal value.
- Clean the home. While cleanliness is not a factor in a home appraisal, it's easier for the appraiser to identify and focus on the elements that bring value to the home when a home is clean.
- Make a good first impression. Add a fresh coat of paint, fix any cracks in the walls or leaks, and make sure the home looks as fresh and new as possible. These easy changes are a great way to boost a home’s value.
- Make necessary repairs. If the homeowner knows of any necessary repairs and can fix them ahead of the appraisal, they’ll have a better chance of a higher appraisal valuation.
- Get organized. If the homeowner has done any renovations or home improvements, they should organize their receipts and take photos of those improvements. That way, they can present the appraiser with hard evidence about what they did to increase the value of their home.
What happens if the appraisal amount is higher or lower than expected?
Mortgage lenders base their loan amounts on the appraisal's estimate of the home's fair market value. This prevents people from borrowing more money than they need to or financing a home priced higher than its worth. This may not seem like a big deal at first glance, but this can lead to the buyer being underwater on their home: If they need to sell the home before its value grows, it may not sell for as much as they bought it
Let’s examine what happens if a house is appraised higher than the purchase price or lower.
If a house appraised lower than the purchase price…
When a lower appraisal happens, this doesn’t mean that the lender will refuse to lend the buyer money to buy the home. But the lender will only issue a loan amount that is equal to the loan-to-value (LTV) ratio agreed to in the proposed contract. The appraisal helps the lender determine the LTV, which compares the size of the loan with home’s value.
The lower your LTV is, the less risky you look to lenders. Ideally, you want to have an LTV of 80% or less. Having a good LTV will not only help you secure a loan, but better rates as well. If you have an LTV of more than 80%, you’ll need to pay private mortgage insurance, which helps mitigate risk for lenders if you default on your loan.
Let’s say a home appraises for $800,000, but the buyer agreed to pay the seller $875,000. If the seller refuses to negotiate down the sales price of the home, the buyer would only be able to get a mortgage for $800,000 and they would owe the seller $75,000 in cash (alongside their down payment) upfront in order to purchase the home.
If a house appraised higher than the purchase price…
On the flip side, if a house is appraised for more than the offer price, the buyer has essentially agreed to pay the seller less than the home's market value — and that's the seller's concern, not the buyer's. The mortgage amount won't need to change, as the sale price is below the appraisal value, so the lender will gladly issue the loan amount required.
What to do if you have a low appraisal
If things don't go according to plan and the buyer makes an offer that surpasses the home's appraisal value, they have a few options for how they can proceed.
Get a second opinion
An appraisal isn't set in stone and it's possible to dispute the original assessment. If the first appraiser doesn't reconsider their initial valuation, the buyer can book an appraisal with a new appraiser to get a second opinion.
Renegotiate the offer
The buyer has the option to go back to the seller and negotiate a lower sales price that fits within the appraisal so the buyer can secure a mortgage loan. If the seller refuses to drop the sales price, the buyer can walk away from the sale, as long as they have an appraisal contingency clause in their purchase agreement.
Back out, but don’t give up
If the buyer chooses to walk away from the sale, that isn’t necessarily game over. They can keep an eye on the home. It may be hard for the seller to find a new buyer who wants to make an offer on the home, and if they can’t find one, the original buyer may be able to come back and see if the seller will negotiate with them again. Awkward? A bit, but doable.
Dispute the appraisal
Appraisals aren’t an exact science, as there is a decent amount of subjectivity involved. The appraiser you choose to work with, the current real estate climate, and a variety of other factors impact appraisal values. If the homeowner or buyer has concerns that the appraisal value is too low, they can dispute the appraisal or get a second appraisal.
To dispute the appraisal, the homeowner needs to do some leg work. The owner should confirm that the appraiser reported the correct square footage and amount of bedrooms and bathrooms, that the appraiser included any major selling points in their valuation, and that the homes they chose as comparables are truly comparable. For example, if the appraiser selects homes with golf course views as comparables and the owner’s home comes with more standard views, that’s not a fair comparison.
The buyer may need to pay for a second appraisal, unless the seller or buyer does this research and presents it to the lender. If the lender thinks a second appraisal is necessary, they will pay for it.
Make up the difference
Suppose none of those above tips help get the appraisal back on track. In that case, the buyer can choose to walk away (if they have an appraisal contingency in their contract) or make up the difference between the appraisal amount and the home's sales price in cash.
A seller with a good real estate agent is likely to price their home fairly and as long as the buyer doesn’t end up in an intense bidding war that raises the price too high, the appraisal value should come back in line with the sales price.