It is not uncommon for homebuyers to offer sellers above their asking price in hopes of edging out the competition. 

But for those relying on financing to close a deal, high offers can be a concern when it comes to the appraisal, especially in a rapidly appreciating market where it’s difficult for appraisals to keep pace with rising prices. To combat potential problems, many buyers are offering appraisal guarantees in their contracts. Let’s take a closer look at the appraisal process and how an appraisal guarantee may help your offer stand out in today’s fast-paced market. 

Understanding home appraisals

A home appraisal is an unbiased professional opinion of a property’s value. Appraisers consider many details when determining value, including location, local market trends, sales prices of comparable homes in the area, lot and home size, age and condition of home, amenities, improvements or renovations, etc. 

Most mortgage lenders require a home appraisal before they approve financing because the home serves as collateral for the mortgage. If for any reason the borrower defaults and the home goes into foreclosure, the lender needs to sell the property to repay the loan.

The mortgage lender chooses the appraiser, and the borrower is responsible for paying the appraisal fee. The cost typically starts around $300, but it can be more, depending on the complexity of the property and the loan type. For example, the Veterans Administration (VA) has a set fee paid to the appraiser. 

What is an appraisal gap? 

A lender will only provide a mortgage up to the value of the home as decided by the appraisal. If that amount is lower than the purchase contract, it is called an appraisal gap. For example, if the price offered by a buyer is $175,000 and the home appraises for $165,000, the appraisal gap is $10,000. 

Beth Graham, with Beth L. Graham Appraisals, says appraisal gaps are more common in today’s competitive sellers’ market. 

“Last week there were only nine active listings in Holt and six in Mason, so we are dealing with extremely low inventory and high buyer demand,” she said. “This environment leads to multiple offer situations in which buyers are more likely to make high offers in order to stand out from the competition.” 

Enter the appraisal guarantee 

It’s first important to understand the difference between an appraisal contingency and an appraisal guarantee. 

An appraisal contingency is a clause written into the purchase offer that typically states that the offer is conditional on the property appraising for the purchase price or a higher amount. The appraisal contingency protects buyers (and lenders) from paying more than a home is worth. Should an appraisal come in below contract, the appraisal contingency allows the buyer the option to pay the difference, renegotiate the price with the seller, or walk away from the deal altogether. 

Because they are not going through a lender, cash buyers can waive the appraisal contingency, but buyers who finance a purchase with a mortgage generally cannot. For this reason, in today’s market, buyers who are financing with a mortgage are adding appraisal guarantee clauses to make their offers more attractive. 

“With an appraisal guarantee, the buyer is agreeing to pay the difference — should there be one — between the sales price and the appraised value of a home, typically up to a certain amount,” said Graham. “So, the contract may read something like ‘buyer will pay up to $10,000 over the appraised value, not to exceed $250,000.’” 

Not only does an appraisal guarantee give the seller assurance that the sale won’t fall through because of the appraisal, but it also saves the buyer from having to back out of a deal or front the entire difference should the appraisal come in much lower than expected. 

While appraisal guarantees can give buyers a leg up in today’s competitive environment, it’s important to work with a trusted, local REALTOR® who can ensure your financial interests are always protected. You can find a list of reputable agents by visiting the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.