Table of Contents
What Is an Appraisal Gap Clause?
Why Are Appraisal Gap Clauses Necessary in Real Estate?
How to Write an Appraisal Gap Clause
Appraisal Gap Clause Example
What To Do When the Appraisal is Less Than the Offer?
Appraisal Gap Clause Bottom Line
What Is an Appraisal Gap Clause?
An appraisal gap clause, also known as an appraisal guarantee clause, is a provision in a real estate purchase contract that commits the buyer to pay their original offer price even if the appraisal reveals a lower value.
This is because lenders won't issue a loan for more than what the home appraises for. After all, they will risk losing money if they have to short-sell it if the buyer defaults on the loan. So, an appraisal gap clause commits the buyer to pay the difference between their offer and the valuation – also known as an appraisal gap.
Why Are Appraisal Gap Clauses Necessary in Real Estate?
An appraisal gap clause comes into play if there is a bidding war and one buyer wants to sweeten their offer. It makes sense if you have your heart set on a particular property and have the cash to pay the difference. In most cases, without an appraisal gap clause, the buyer has the right to walk away from a sale if the appraisal comes in low. So, a seller may be hesitant to accept an offer that exceeds what they think the home may be worth. An appraisal gap clause signifies that the buyer is aware that their offer may be inflated, but they are willing to take the risk to secure the property.
How to Write an Appraisal Gap Clause
1. Identify the Parties and Property
The first step in writing an appraisal gap clause is to identify the parties and the property. Clearly state the names of the buyer and seller, and identify the property address.
2. State the Purchase Price
Next, you will state the agreed-upon purchase price for the property. This is an essential piece of information in an appraisal gap clause.
3. Define the Appraisal Gap
Specify what will happen if the appraisal comes in below the purchase price. This typically involves the buyer agreeing to cover the difference up to a certain amount. You should also establish a cap on how much the buyer is willing to cover. This protects the buyer from an excessively low appraisal.
4. Include an Option to Terminate
Provide the buyer with an option to terminate the contract if the appraisal gap exceeds the specified amount, ensuring they can walk away if the financial gap is too large.
5. Address Earnest Money
Clarify what happens to the earnest money deposit if the buyer decides to terminate the contract due to a low appraisal.
6. Legal Language and Signatures
Ensure the appraisal gap clause is written in clear, legally sound language and that it is included as an addendum or directly in the purchase agreement. Both parties should sign the agreement.
Appraisal Gap Clause Example
In the event that the appraised value of the property, as determined by a licensed appraiser, is less than the agreed-upon purchase price of $XXX,XXX, the Buyer agrees to pay the difference between the appraised value and the purchase price, up to a maximum of $XX,XXX. If the appraisal value is lower than the purchase price by more than $XX,XXX, the Buyer has the option to either pay the additional difference or terminate this Agreement and receive a full refund of the earnest money deposit.
What To Do When the Appraisal is Less Than the Offer?
- Pay the Difference
- Renegotiate
- Challenge the Appraisal
- Get a Second Opinion
- Cancel the Sale
1. Pay the Difference
The simplest option is to pay the difference and proceed with the sale. Any time you sign an appraisal gap clause, you should understand that there's a possibility you may be required to foot the bill. So, if you can't afford it, you shouldn't agree to include the clause. You can also set a limit on the appraisal gap, so you won't be expected to pay more than you can realistically afford.
2. Renegotiate
Another option is to renegotiate with the seller. This may be tough to do if there is interest from other buyers, but it's worth a shot. You could try to get them to accept a price equal to the appraised value, eliminating the gap. Or you could convince them to meet you halfway to help reduce some of your financial burdens. They might be willing to renegotiate to save the deal if there isn't much attention from other buyers and they're looking to sell quickly.
3. Challenge the Appraisal
If you believe the appraisal may be inaccurate, you could challenge it. While appraisers are licensed professionals, that doesn't mean they're above making a mistake or displaying negligence in their work. So, if you have good reason to believe that the valuation isn't accurate, you can dispute it. But be prepared to show evidence to support your claims. You can't challenge an appraisal just because you don't like the results, so this is only an option if there is adequate evidence for reconsideration.
4. Get a Second Opinion
If your lender refuses to challenge the first appraisal, you could always try your luck with a new lender. They will send a different appraiser to evaluate the property, who may offer a more favorable opinion. Unfortunately, finding a new lender will be time-consuming, as you'll have to go through the pre-approval process all over again. Plus, there's no guarantee that the second appraisal will differ significantly from the first. But, if you feel confident that the first appraisal was inaccurate and your lender won't agree, you can always seek a second opinion.
5. Cancel the Sale
If all else fails, you may be able to back out of the sale. Most purchase contracts have an appraisal or financing contingency that allows you to back out if the appraisal is low. However, it gets more complicated if there is an appraisal gap clause. You should consult your broker and attorney before canceling the sale because you may have to forfeit your deposit, depending on what's stated in the contract.
Appraisal Gap Clause Bottom Line
When you make an offer on a home, there is always the chance that you're offering more than it's worth. An appraisal gap clause can help smooth the transaction process and protect both buyers and sellers from potential financial discrepancies caused by varying appraised values. By using an appraisal gap clause, you can enhance your bid if you feel confident in your ability to cover any potential shortfall. But be sure to determine how much you're comfortable paying and don't agree to something you can't afford, or you could be stuck with a hefty bill at closing.