If you’ve ever been to the UK, you may be familiar with the phrase, “Mind the gap”. It is a warning to passengers of the London underground to avoid stepping into the gap between the train and the platform.
“Mind the gap” also aptly describes a current trend in the real estate market, specifically the trend of buyers covering an appraisal gap.
An appraisal gap occurs when a property appraises for lower than the agreed upon purchase price, and is the difference between the two e.g. if the purchase price is $100K, but the property appraises for $90K, the appraisal gap will be $10K. If the property appraises for higher than the purchase price there will not be any appraisal gap.
It is important to understand that the amount of money a lender will loan to a buyer is based on the lesser of the appraised value or agreed upon purchase price. Therefore the buyer may be responsible for paying any appraisal gap in cash at closing, in addition to their down payment and closing costs.
Although the buyer and seller would have entered into a binding purchase contract, the buyer’s exposure to an appraisal gap can be reduced, or eliminated, through the terms of the contract. The standard Columbus Board of Realtors residential purchase contract contains an appraisal contingency which provides that the buyer and seller shall renegotiate the purchase price, or the buyer may exit the transaction, in the event of an appraisal gap. However, in today’s highly competitive sellers market, many buyers are eliminating the appraisal contingency, or offering to cover a portion of any appraisal gap. This is known as gap coverage. Covering all or a portion of an appraisal gap significantly strengthens a buyer’s offer, but also requires more cash to close.
In the current seller’s market, an appraisal gap is a very common occurrence. For example, of 40 sales that closed within the past 30 days in the Columbus area, 3 in 4 sold above the list price with the buyers paying an average 7% over list price ($10,000 to $40,000). This sample is not necessarily reflective of the entire Columbus market, but it does reflect what many other agents are experiencing day-to-day.
“Mind the appraisal gap” is a warning for buyers to be cognizant of the risk of an appraisal gap occurring should they offer to purchase a property for an amount that is significantly above the property’s list price. Exposure to an appraisal gap can be eliminated or mitigated via the terms of the purchase contract, and I recommend working with your real estate agent to determine the right strategy for you.