Before you agree to sign an Appraisal Gap Insurance Clause with your offer, be sure to know the financial implications!
We are honored to have John "JJ" Jeffrey, Mortgage Specialist (NMLS 201863) with Westerra Credit Union discuss the risks of overbidding to get under contract. In this episode, we speak specifically about the financial implications of signing an An Appraisal Gap Insurance Clause in your offer to purchase a home.
What is an appraisal?
An appraisal is a professional estimated value of a "subject property" or the home you are planning to purchase and is completed by a licensed appraiser. The value of your new home is created by gathering prior home sale comparables, current market trends, and aspects of the home (e.g., amenities, floor plan, square footage) and condition of home (just to name a few). The more comparables that an appraiser can find to help argue the validity of your contract purchase price, the more likely the home will appraise. Think of a home "appraising" synonymous to being "of equal or more value" than your contract purchase price.
Who performs an appraisal?
Only licensed appraisers are allowed to perform an appraisal. A neutral third party is consulted to complete an appraisal and report back the results to the lending institution.
Why do lending institutions require an appraisal?
Remember that the bank is going to loan you money based off the value of the property. Your property is essentially "collateral" for your loan, and God forbid should you default on your mortgage payments, the bank has their loan covered with the value of the property. Hence, a bank will not loan a buyer more money than the value of the home, for this would ultimately be placing the lending institution at financial risk.
What does it mean if the property does not appraise?
This simply means that based off the comparables in the neighborhood, the appraiser found the property value to be less than your contract purchase price. This creates what is called an appraisal gap. For example, the listing price of the property was $600,000 and you put in an offer to purchase the home for $630,000. The home appraises at $620,000. You now have an appraisal gap of $10,000, and the bank will not loan above the appraisal amount of $620,000. Remember that you sent an offer to purchase the home at $630,000. So what do you do? In a normal situation, you can object to the appraisal and get your earnest money back or try to re-negotiate a lower purchase price. The difference between the purchase price and appraised value must be financed in cash by the buyer. Ouch!
Danger of Including an Appraisal Gap Insurance Clause in your offer
1. In a strong seller's market with low inventory, buyers may often find themselves making offers well above the asking price. Sellers obviously would love to entertain the highest offer possible; however, they do not want to risk falling out of contract because the property does not appraise. This is why sellers are asking for an Appraisal Gap Insurance Clause to be included in the offer because it provides extra insurance to the seller -not the buyer! Should the property not appraise, the buyers agree to come up with the difference in cash at the closing table. If the buyer backs out, the seller can keep the earnest money.
2. An Appraisal Gap Insurance Clause forfeits the buyer's right to exercise the appraisal objection and be entitled to their earnest money. So if the buyer decides to back out of the contract because of the property not appraising, they will lose their earnest money.
3. Be sure to have your agent pull comparables of the listing price of the property to know where the approximate price ceiling could fall in appraisal before submitting an offer.
4. Always consult your Realtor before signing an Appraisal Gap Insurance Clause so that you can understand all the potential financial implications! You should never feel pressured to make an offer that you are not comfortable with.
For further questions about overbidding, appraisal, and purchasing a home in sellers market please feel free to contact either JJ or myself directly!
John "JJ" Jeffrey 303-618-1990 Email: firstname.lastname@example.org
Chadwick 720-666-9805 Email: email@example.com