In this market, an appraisal gap guarantee is more and more the norm, if you want to be able to buy a house and you are not paying cash. And let’s face it, that is most of us.
What is an appraisal gap guarantee?
An appraisal gap is the difference between the appraised value of the house and the purchase price. When a buyer guarantees to pay more than the appraised price, that is the appraisal gap guarantee. A lender only lends 96.5%, 95% or 80% of the appraised purchase price. If it doesn’t appraise for the purchase price, the choices are to lower the purchase price, or for the buyer pays the difference.
In a hot market, appraisals usually lag the purchase price, which causes appraisals to come in low. When inventory is low, like it currently is, there are sometimes 10 or more buyers for each house. That drives up home prices well above appraisal.
Isn’t it insane to be paying above the appraised value?
That depends on whether you think we are in a housing bubble or not. You can see my thoughts on that in the video “Are We In A Housing Bubble?“.
But here are some facts to consider:
- There are 78 Million Millennials right now, which is 31% of the Population (Boomers were 27% at peak).
- 70% plus of them have said they desire to buy a home in the next 3 years, which adds 50 million plus buyers to the market.
- According to the National Association of Realtors, 2021 to 2022 will be the Millennials peak home buying years.
- According to the National Association of Mortgage Bankers – 45% of all mortgage applications are with Millennials.
With facts like these, it doesn’t look like demand for housing is going to go down any time soon.
What is this going to do to home prices?
According to the Home Buyers Institute, prices are expected to continue rising through the rest of 2021 and into early 2022.
If home values are going to rise by anywhere between 5-10% in 2021 and into 2022, would an appraisal gap make sense?
Let’s do the math.
Say you are buying a house that is listed at $250,000. Here is Fayette County GA, that is low end of the market, and there is a ton of competition, including from cash buyers.
You offer $265,000 (6% over list price) with a $15,000 appraisal gap guarantee. Congratulations, you won the house!
But then the appraisal comes in at $255,000 and you make up the difference by bring an additional $10,000 to closing. Is this a smart idea?
Let’s be conservative and say that housing values are going to increase by only 3% over each of the next 2 years. That means that your $265,000 house will be worth $270,529 in 2 years. Well worth the $10,000 in appraisal gap if you are planning on staying in your house for at least 2 years.
If the house increases in value by 5% over the next 2 years, the value would be $281,137. Definitely worth the $10,000 appraisal gap.
If you are staying in your house for a few years and you expect housing values to increase, it makes sense to pay an appraisal gap, even if the housing market does not stay as hot as it currently is.
However, you have to do the math. It may not make sense in every situation and I am not advocating blanket appraisal gaps.
Talk to your realtor. Make an offer that makes sense for you, but don’t reject an appraisal gap out of hand. Do the math and get your house while interest rates are low!