You and your buyer’s agent have successfully negotiated with the seller on a property, and all parties have agreed on a price. Everyone is happy, but then the appraisal comes back from the bank and they say the property is worth $15,000 less than contract price! What should you do? Should you ever pay more than appraised value for a home?
This is a common problem. According to a recent survey by the National Association of Realtors, about one in five respondents faced appraisal issues. Bank appraisal shortfalls are a problem in both rising and falling markets, and figuring out how to proceed is not simple.
It is important to remember that the appraisal is ordered by the lender. The lender wants to know the value of the asset they are loaning against so they have proper collateral backing up the loan. Should the buyer default on the loan, the bank is going to sell the property to pay off the loan. It does not necessarily mean that the home is not worth the price that the buyer and seller have negotiated.
Should you ever pay more than appraised value for a home?
If your appraisal comes in low, there are five ways you can proceed.
- Dispute the value. Review the appraisal with your agent and look at the comparable homes they used. Most always, appraisers are experienced specialists in their craft and take great pride in producing an appraisal that accurately reflects value. However, it is possible that they overlooked a good comparable home, or that ― if brought in from an outside area ― they may not understand the nuances of the market. If you and your agent find what you think are errors or omissions, ask the bank for an appraisal review.
- Switch lenders. You will get a new appraisal. This will cost you more money and may yield a similar result as the first appraisal. If you think there were issues with the appraisal and the bank won’t respond, this may be a good option.
- Renegotiate with the seller. More likely than not, all parties want the transaction to close. Often, the home seller will be willing to negotiate with you to keep the deal moving along. It’s fairly common to meet in the middle. If you do not have a strong need in closing the deal, then ask for it all and walk if they do not concede. If you are in a strong seller’s market, and the property has desirable features, you will find yourself back in the market for a new home and potentially missing out on a great purchase. Remember that the seller is vested in this deal, too. If the seller has to put the property back on the market, they have lost at least a month. Human nature being what it is, that seller is probably already spending the proceeds from this sale in their head. Most likely, they want to close!
- Pay the contract price. If the shortfall is manageable and you feel right about the house, then close on the house! Buying a home is a quality of life and lifestyle decision, not just an investment. You will need to bring additional cash to satisfy the bank, though. In the end, an experienced agent may not be able to negotiate a lower sale price! In a hot seller’s market, for instance, another buyer may be waiting. If you don’t want the house, someone else does! That other buyer is just waiting for you to open up your contract by asking for a price reduction so the seller can bump you out and take the other (maybe even higher) offer!
- Walk away from the deal: If your contract is properly written, then you should be able to exit the contract and get your security deposit back when an appraisal comes in below contract price. In a seller’s market though, you will most likely be competing with other offers when you write your contract. A contract with appraisal language will likely be beaten out by a similar offer that lacks strict language about an appraisal shortfall. Your agent should advise you of the pros and cons.
Negotiating the home inspection and negotiating an appraisal shortfall are two areas where having an experienced buyer agent is extremely important. An experienced agent can help you navigate through these difficult decisions and give you the information to help you make the decision that is right for you.
How can you get past an appraisal shortfall?
An experienced agent will know exactly how to help you navigate through an appraisal shortfall.
- Understand your needs. An experienced agent is a great communicator and is always asking the buyer clarifying questions to understand your wants and needs. They can then better advise you on how to proceed in this situation. Every client has a different risk tolerance, a different need and desire to move right now, and a different amount of funds available to cover a shortfall. If your agent is not seeking this information from you, then consider finding a new agent.
- Help you see the long view. During the great recession, I sold many homes that came in under appraised value. At that time (2008-2010), appraisals were coming in low because banks were applying a falling market factor. This meant that the banks would compare your purchase property to comparable homes and then deduct a factor for a falling market! I have many examples where a client chose not to buy a home because the home appraised below purchase price. These days, that same home could sell at twice the 2010 price. So, you see, it is not simple. What appeared to be a bad investment then, was actually a great buy!
- Understand the market. You may find that you are “overpaying” now, be at market value in three months, and in the black in one year. Looking in the rear view mirror and seeing affordability dwindle, you’ll be glad you bought when you did. You and your agent will need to come to agreement as to your perspective on the continued market growth, as well as where you feel prices are going and why.
- Advise you about the property with regard to the appraisal. Your buyer agent can help you when the home has unique characteristics (such as location in the neighborhood, location relative to shopping, schools and work, and other special characteristics that cannot be replicated in another property) where it may be fine to pay above appraised price. This is a discovery discussion, not an agent agent persuading you to move forward.
Deciding to pay more than appraised value for a home is a decision best considered with an experienced buyer agent ― one who can clearly communicate all of the pluses and minuses of the situation and knows you well enough to make informed recommendations. Choose an agent that has seen at least one full market cycle and works alongside a group of experts that can assist you every step of the way in your home purchase. Only then can you feel confident that you are making the right choice.