By Peter Miller
Question: We want to list our home for sale and have spoken with several brokers. Of course, we want the highest price, but one broker warned that offers can fall through if buyers are willing to pay too much and can’t. Is that really possible?
Answer: Real estate agreements rarely fall through, but it does happen.
According to the National Association of Realtors (NAR), in the period from February through April 2022, just 7% of the pending sale contracts it tracked fell through or were terminated. That means 93% were successful.
The broker was likely warning about the dangers of the “appraisal gap”, a situation that can lead to a lot of grief for both buyers and sellers.
When a home sale depends on mortgage financing, the lender requires an appraisal. The lender will then finance the property on the basis of either the sale price or the appraised value, whichever is lower.
Why doesn’t the lender just provide financing based on the sale price accepted by the buyer and seller?
The lender is putting up the bulk of the money and for that reason wants to be cautious. If the price cannot be justified by recent home sales, then the lender will not want to make the loan, there’s too much risk.
In other words, if a home sells for $500,000 but is appraised at $480,000, the lender will use the lower figure to calculate the maximum loan amount it’s willing to offer. If the maximum loan-to-value (LTV) ratio is 80%, it means the lender will finance $400,000 if the property is worth $500,000. But the lender will only lend $384,000 for a $480,000 valuation.
In this example there is a $20,000 appraisal gap – the difference between $500,000 and $480,000.
There is also a $16,000 difference between the amount of cash required from the buyer – the difference this time $400,000 in financing (80% of $500,000) and $384,000 in financing (80% of $400,000).
The seller accepted a $500,000 offer and not $480,000. What happens next? There are several ways to deal with an appraisal gap.
First, the buyer can put up the additional $20,000. Not every buyer, of course, has the cash to do this.
Second, the seller can drop the price by $20,000. That’s not very likely in today’s market.
Third, the buyer and seller can meet in the middle. The buyer will put up an extra $8,000 in cash and the seller will reduce the price to $492,000.
Fourth, the buyer can appeal the appraisal value.
Fifth, the purchaser can ask if the lender will accept a second appraisal.
Sixth, the buyer can look for financing with the same lender but a different loan program.
Seventh, working with a different lender might also be an option, but beware of time delays, the need for a new mortgage application, the possibility of not qualifying, etc.
Eighth, the deal can fall through. This can lead to a down payment loss for the buyer and possibly other penalties.
For details and specifics, speak with a real estate broker or an attorney who handles local real estate transactions.
Email your real estate questions to Mr. Miller at email@example.com.