Risky Appraisal Waivers and Gaps – Why and When to Apply
It’s the new rage if you are a seller or a buyer, but what is an appraisal waiver?
In the standard sale agreement, the boilerplate language states that the “Sale is subject to the purchaser and the property qualifying for the loan.” What does this mean? If you are a cash buyer, then it does not apply to you. In fact, there is no provision to protect you requiring an independent third-party provide an appraisal to confirm the value of the home. However, when it comes to the bank lending on the property, they will confirm that you as the purchaser have the financial credentials required for the loan – that you qualify, and that the property qualifies for the loan amount. This means that an independent third-party appraiser must validate that the price you are willing to pay is equivalent to or less than what the property is worth based on the appraisal.
In a typical market, most buyers are hoping that the appraiser will validate their business decision and confirm that they are paying the true market value based on the appraisal. If the appraisal comes in above your purchase price, then you are a savvy buyer and got a good deal. If the appraisal comes in below, you as the buyer have an “out”. You can cancel the contract and have your earnest money returned. For decades buyers have relied on the appraisal to protect them from overpaying for the home.
In 2021 the market has shifted and the reason for the current appraisal waiver and gap rage is quite simple. Today, nearly two thirds of homes are selling for above the listing price. In many cases they can sell upwards of 5 to 20% over the listing price. This raises the question, will the property qualify for the bank loan, or in other words, will the home appraise for the actual sales price?
Buyers have two compelling reasons they are willing to turn a blind eye to their bank appraisal. First, they are prepared to pay above the appraised price for the opportunity to purchase a home while interest rates are so low, and inflation seems to be never ending. Second, they are competing with multiple buyers for the home, some of whom may be cash buyers and will not require an appraisal. Other buyers may waive the appraisal contingency or offer what is referred to as a provision to cover the appraisal gap with cash.
The true winners with these new practices are the sellers. They are often selling their homes under the current market conditions for record prices and will not have to be concerned about the appraisal value. As for buyers, here is how it works – say you saw a home listed for $900,000 and then bought it in a bidding war for $1,000,000 and you waived the appraisal contingency. Your down payment is $200,000 (20%) and you will be financing $800,000. If the bank appraisal comes in at $1,000,000 or higher, you as the buyer are all set to close. However, if the appraisal comes in at the original list price of $900,000, the bank will require that you put 20% down based on $900,000, or $180,000, as well as produce the $100,000 needed to cover the appraisal shortfall. This means you would be required to come to closing with $280,000 rather than your initial offer amount of $200,000. To successfully close this transaction, you need to have the funds available to cover the difference and may need to provide proof of funds at the time you make the offer.
When offering well over the listing price, you could choose to include language in your offer indicating you will cover an appraisal gap of say, $50,000. Based on the scenario above, if the home appraises for only $900,000, then technically you are only willing to pay $50,000 over the appraisal and thus the transaction may not qualify for the loan. In this case, you could walk away and get a full refund or try to renegotiate with the seller. In the end, one should only stay within their financial limitations, and if you do either waive the appraisal or offer to provide “appraisal gap” coverage, then make sure you have the cash available to do so.
To learn more, reach out to your ELEETE Realtor to best understand these new tools and the current real estate climate.