Across the country and especially here on the Front Range of Colorado, it’s a sellers’ market. Prices are going up, inventory is low, bidding wars are common, and it feels harder and harder to buy a home. One factor impacting homebuying in this sellers’ market is an appraisal gap. To better understand this real estate term and what it means for homebuyers, we reached out to our experienced Elevations Mortgage Loan Officers.
Why do you need an appraisal before you buy a home?
An appraisal is a necessary part of the homebuying process and impacts the amount you can borrow from your lender in the form of a mortgage loan. Your home loan is based on the appraisal’s estimate of the home’s fair market value. The appraisal determines this fair market value through data, comparable properties chosen within a specific time frame and subject area to confirm the property’s value. The process is designed to keep your lender from lending you more than is needed to purchase the home.
What happens if the appraisal is lower than my offer?
Your mortgage loan is based on the loan-to-value (LTV) ratio agreed to in the proposed contract. The LTV compares the loan amount you’re getting with the value of the home. If the appraisal for a home you want to purchase comes in below the purchase price of the home, you might need to bring more money to the table at closing to make up the difference. This is known as an appraisal gap.
Appraisal gap explained
An appraisal gap is a discrepancy that occurs when your offer to buy a home is higher than the appraised value of the home. This is a common issue for buyers in competitive sellers’ markets. When there’s an appraisal gap, you (the buyer) will agree to bring a cash difference to the table at closing and will state how high you are willing to go to make up this gap in your offer. This can show the seller you are a determined buyer and, like them, you believe the home is worth more than the appraised value.
For example, let’s say you’re buying a home for $460,0000, and your real estate agent writes an appraisal gap guarantee clause in your offer that states you will pay up to $10,000 over the appraised value of the home. If the appraisal comes in at $450,000, you will bring the $10,000 appraisal gap difference to closing.
Appraisal gaps in Colorado
The homebuying competition is particularly high for properties in Colorado under $750,000, and this is where appraisal gaps may happen most often. Appraisal gaps are commonly between 5-10% of the contract price, but they can be more.
Be prepared for the homebuying process
Have questions about how an appraisal gap would fit into your homebuying budget in this competitive market? You can set up a no-obligation meeting over the phone, in person or virtually with one of our experienced Elevations Mortgage Loan Officers who work across the Front Range. Our team can help you understand your homebuying options, learn more about the market and make a plan that fits your financial goals.