Once you settle on an asking price and get your offer accepted, you’ll likely turn your attention toward financing your new home. While you may think the deal is done, keep in mind that the contract sales price may not always align perfectly with the appraised value. Fortunately, a low appraisal isn’t the end of the world.
The appraised value is what the mortgage lender is concerned with as it protects the bank in the event you default on your loan. They don’t care what you’re willing to pay for the home, rather what its market value is. After all, why would the bank want to give you any more money than what your property is actually worth?
Believe it or not, it’s not uncommon for a property to be appraised for less than the purchase price. It actually happens all the time because home buyers will often overpay for a property to beat out other bidders.
If this happens to you, the lender will use the lesser of the purchase price and appraisal value to set the maximum mortgage amount. Here are some options to save the deal and close that mortgage.
Renegotiate the Purchase Price
Original purchase price: $230,000
Appraised value: $220,000
New purchase price: $220,000
If the appraised value comes in lower than the contractual purchase price, you may be able to renegotiate the asking price so that it falls in line with the appraised value of the home. Here’s the kicker. If you don’t have an appraisal contingency in the purchase contract, you’re obligated to buy the home regardless.
If that’s the case, you’ll need to come in with extra money to make the deal work, which may require putting more money down and/or being subject to a higher interest rate on your loan. You may even need a second mortgage if you only intended to take out one.
However, if your purchase contract did come with an appraisal contingency, the seller will need to work with you to make things right. If there’s an impasse, the buyer can walk away from the deal and collect their earnest money deposit. But typically the seller will work with the buyer to make good on the deal, though a huge gap in appraised value and purchase price could kill the deal outright.
Either way, the buyer will usually attempt to work something out with the seller if the value comes in far lower than the purchase price, though they aren’t obligated to do so if there isn’t a related contingency.
If the seller wants to make the deal work, you may be in luck regardless of what contingencies are in place, it all depends on the unique characteristics in your particular transaction.
Modify the Financing Terms
Original purchase price: $110,000
Appraised value: $100,000
Old down payment: $22,000
New down payment: $30,000
If the appraised value comes in slightly lower than expected, it’s not the end of the world. Many buyers put down 20 percent when they purchase a home, so there’s typically a cushion if the value comes in a little short. If this is the case, you can work with your loan officer or broker to adjust the loan amount as needed.
For example, say the purchase price is $110,000, but the appraised value turns out to be $100,000.
You were originally planning to put down 20%, or $22,000, which results in a $88,000 mortgage at 80% loan-to-value (LTV).
You want to keep your LTV at 80% to avoid mortgage insurance and secure favorable mortgage rate pricing, so now you’ll only be able to borrow $80,000 from the lender if they value the property at $100,000.
But you’ll still need to come up with that remaining $30,000 to satisfy the full purchase price, assuming it can’t be negotiated lower with the seller.
In other words, you’ll need to come up with $20,000 for the down payment and another $10,000 for the difference in value. Simply put, if the house value is lower, your borrowing power will be limited.
Alternatively, you could ask for a larger loan amount. So instead of an 80% loan, a 90% loan, or $90,000, based on the new $100,000 value. Then you’d only need $20k for down payment, less than you originally set aside.
Just keep in mind that if you need to borrow more, it will result in a higher LTV, which may drive your interest rate higher. Mortgage loans typically get priced in LTV tiers, from 65-70%, 70-75%, 75-80%, and 80% or greater.
The higher the tier, the higher the adjustments and the resulting interest rate. And it can vary greatly, so find out exactly where you stand before you commit to the modified terms. Also note that LTVs above 80% generally require mortgage insurance.
Tip: You can also take out a second mortgage for the amount you need beyond 80% LTV to avoid mortgage insurance and keep the interest rate from creeping higher.
Get a Second Opinion (Appraisal)
Not all home appraisals are created equal, and the same is true with appraisers. While they are meant to be objective, they are still influenced by the human being creating the report (unless it’s an AVM).
If the value falls short the first time around, try, try again. You can always ask the lender to get a second appraisal, or order an enhanced review (broker price opinion or BPO) if you think the value is there. Keep in mind that this can backfire, and the value could come in even lower with a more in-depth review.
If you’re not getting the value you want/need with one lender, you can always take the loan to another lender with the hope that they’ll come up with something different (higher).
Again, this may not work out but it could be worth a shot. You just have to be careful not to pay for a bunch of appraisals in the process.
Remember, appraising homes is not a perfect science. There will always be variance, and with that comes options.
Of course, this is one more reason to save for a larger down payment. That way you actually have options if things don’t go exactly according to plan.
Read more: How to get a high house appraisal.