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Why an appraisal gap could lead to a canceled home closing

On Behalf of | Jul 1, 2024 | Real Estate Law

Real estate transactions are relatively complex. The buyer and seller both need to protect their interests, as does the lender providing financing. Even in a scenario where a buyer makes a cash offer, there are usually weeks between when the seller accepts the offer and the final closing.

The process in the interim involves finalizing financial arrangements and validating the value of the property. Lenders typically require appraisals before they fund mortgages. In some cases, the appraisal may come back lower than the amount offered on the property. That appraisal gap could potentially lead to the cancellation of the scheduled closing.

An appraisal gap is a source of lender risk

The purpose of an appraisal is to validate the fair market value of the property. Requiring an appraisal helps the lender protect its capital. The lender may need to recoup the money used to fund the mortgage if the buyer defaults and the lender must foreclose. Therefore, what another party may pay for the property is an important consideration.

In an appraisal gap scenario, the amount the buyer offers is more than a professional appraiser believes the property is actually worth. Lenders may not agree to finance a transaction when there is a risk of taking a loss in a foreclosure scenario.

How can buyers handle an appraisal gap?

There are typically three options for overcoming an appraisal gap. The easiest is to produce capital to cover the gap between the offered sale price and the appraised value of the property.

If buyers can’t do that, they may want to request a second appraisal. There is a possibility that a different appraiser might have a different perspective on the home. It may sometimes be necessary to secure a mortgage from a different lender and then reappraise the property.

Finally, the third option is to renegotiate with the seller. The seller might agree to a lower sale price to close as scheduled. Other times, they may hold firm. At that point, it may be necessary to cancel the closing.

Understanding what challenges can imperil a scheduled real estate closing can help buyers better prepare for one of the biggest transactions of their lives. The right approach to making an offer, including the addition of contingencies to the purchase agreement, can help buyers reduce their risk.