In an increasingly volatile luxury housing market, buying aspirants are resorting to risky strategies to secure their dream homes. One such strategy gaining traction is waiving the so-called "appraisal gap," a phenomenon that arises when the appraised value of a home is less than the contract price. According to CoreLogic Inc., a leading real estate data provider, appraisal gaps were a part of 11% of residential transactions in June 2023, often occurring in tight markets where buyers are forced to bid above the asking price.

Waiving the appraisal gap essentially means that a buyer agrees to proceed with the purchase at the negotiated price, regardless of the home’s appraised value. While this is a boon for sellers, indicating a serious buyer, it also shifts a significant risk to the buyer. They could potentially lose their down payment if they are unable to bridge the gap between the appraised value and the contract price. This risk-laden strategy is being seen as a necessary evil by many, especially in markets where supply and demand challenges persist, according to Shawn Telford, CoreLogic’s chief appraiser.

Navigating The Appraisal Gap in Hot Housing Markets

While the luxury home market experiences a slump in many places, certain regions continue to see fierce competition with bidding wars still a common occurrence. According to data from CoreLogic Inc., a real-estate data and services provider, appraisal gaps were a feature in 11% of residential transactions in June 2023. This phenomenon happens when homes appraise for less than the contract price, common in tight markets where bids often exceed asking prices. Shawn Telford, CoreLogic’s chief appraiser, attributes this to supply and demand challenges in specific markets.

Waiving the Appraisal Gap: A Buyer’s Gamble

In an attempt to out-compete other potential buyers, some may opt to waive the appraisal gap. This means the buyer will proceed with the purchase at the agreed-upon price, regardless of the home’s appraised value. This decision can be beneficial for sellers, as it signals a serious buyer committed to the deal. However, this also shifts a significant amount of risk onto the buyer. If they lack the necessary funds to cover the difference, they stand to lose their down payment.

The Impact on Mortgage Contingency

Despite real estate agents often referring to "appraisal waivers," most states do not include an appraisal contingency in a standard home-purchase agreement. Instead, the issue arises within the context of the mortgage contingency. A lender’s mortgage commitment is dependent upon receiving a satisfactory appraisal. If the appraisal comes in too low, it can affect the loan-to-value ratio used by a lender to qualify the buyer, often resulting in the lender approving a lower mortgage amount. For instance, for a buyer putting down 20% on a $1 million home, if the appraisal came in for $900,000, the lender would only finance $720,000, requiring the buyer to come up with an additional $80,000 in cash to close the deal.

The Role of Appraisal Waivers in Competitive Bidding

Appraisal waivers can serve as a significant incentive for sellers when deciding between multiple offers. Donna Soda, an agent with Premier Sotheby’s International Realty, has seen instances where buyers and sellers renegotiated to lower the purchase price if the appraisal came in too low. However, she has also encountered situations where the buyer agreed to waive the appraisal gap and had to come up with an additional $100,000 in cash at closing when the appraisal was too low on a $2.3 million purchase.

Considerations for Prospective Buyers

Waiving an appraisal gap is a decision fraught with financial risk. Buyers should do their due diligence by checking public records for recent sales or consulting with their real estate agent on comparable sales. Buyers can also mitigate potential risk by capping their liability. For instance, they can offer to waive the gap up to a specific amount, preventing them from overpaying drastically. Additionally, the Consumer Financial Protection Bureau suggests buyers can request a "reconsideration of value" if they believe the initial appraisal is inaccurate.

Takeaways

The decision to waive an appraisal gap should not be taken lightly. Buyers need to be aware of the potential financial risks and should ensure they have sufficient funds to cover any potential differences between the contract price and the appraised value. Capping liability and requesting a reconsideration of value are possible strategies to mitigate risk. Buyers should also remember that while the allure of securing a dream home can be strong, it’s crucial to avoid making decisions based purely on emotions. Always back your decisions with research and data.