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How a cooling home market might lead to an appraisal gap

On Behalf of | Dec 27, 2022 | Real Estate, Uncategorized

There are positives and negatives to just about any timing decisions that you make regarding real estate purchases. Buying when the market is hot might mean having a shot at some incredible properties whose owners will only list them when prices reach a certain point. Buying when there isn’t much competition on the market might mean that you can get lower-cost properties and make fewer concessions as a buyer.

There are also transitional times when the market is improving or softening, and those changes can have major implications for both buyers and sellers alike. Less competition and lower asking prices are both benefits of a cooling residential real estate market. However, dropping prices can also mean new challenges for would-be homeowners.

For example, they have to consider the elevated risk of an appraisal gap stalling out their closing.

What causes appraisal gaps?

An appraisal gap is what happens when there is a sizable difference between the amount a buyer offers the seller for the purchase of a home and what a professional appraiser determines the property is actually worth. In a cash transaction, the buyer can potentially choose to move forward with the transaction despite the lower appraisal.

In a financed transaction with a mortgage, moving forward may not even be an option after a low appraisal. Lenders impose numerous rules on finance transactions for their own protection, not the least of which is the refusal to finance more than the property is worth.

How can you protect against an appraisal gap?

One of the easiest ways to avoid an appraisal gap is to offer what you think is reasonable, not the highest amount that you can afford for a property. You can also keep some cash in reserve as a means of overcoming that gap should it complicate a transaction.

Sometimes, buyers can move forward with a purchase by changing lenders and having a new appraisal done, but the risk exists for the market to continue softening and the price to drop even more between the first appraisal and the second one.

For many buyers, the best protection related to an appraisal gap is the inclusion of an appraisal contingency in their offer. That way, even if the transaction falls through, they won’t be at risk of losing the 1% or more of the purchase price that they offered as earnest money when initially suggesting the transaction to the seller.

Protecting yourself against known risks while trying to buy real estate often requires careful planning from prospective property owners.