What To Do If The Home Appraisal Is Too Low

As a buyer, you don't expect a low appraisal, as it isn't the norm. When it does happen, it seems to sneak up and wallop you over the head just at the moment your dream home seems within reach. While getting a home for a low price is appealing, a low appraisal means that the house is worth less than the agreed-upon sales price, and that means your lender won't give you the mortgage for which you asked.

While a low appraisal can doom a home purchase, it isn't an automatic deal breaker. There are paths forward to closing that dream house deal if both parties want to keep moving ahead.

An appraisal is a written evaluation of real estate prepared by a professional. Anyone who owns a home can schedule a home appraisal at any time. This can occur when the homeowner wants to refinance a mortgage, but most appraisals happen when a home is up for sale.

The appraisal that happens during a home sale is not for the direct benefit of the seller or the buyer. Rather, it is done to protect the buyer's mortgage lender. While the buyer may be making a down payment, the lender is usually contributing the bulk of the purchase money, and it is intending to use the house itself as security. If the buyer defaults on mortgage payments, the lender has the right to sell the property and use the proceeds to repay its loan.

That is why lenders insist on home appraisals. They want to be sure that the house for which they are lending money is worth at least the amount they are lending. Lenders select the appraiser, and the homebuyer is the one who pays for it.

Every offer on a property contains at least a few contingencies. A contingency is a condition that must be fulfilled before the buyer is locked into the deal. If you are financing with a mortgage, the offer will always include an appraisal contingency (unless you choose to waive it). This specifies that if the house doesn't appraise at or over the sales price, you can reject the agreement.

Why would you care about the contingency? It's because your mortgage is based on it. That is, the loan for which you applied specifies that you come up with a certain percentage of the purchase price as a down payment, and the lender finances the remainder with a loan. For example, if the sales price is $200,000 and you are making a 20 percent down payment, or $40,000, then the lender is financing 80 percent, providing $160,000. If the house appraises at $180,000 instead, the lender will only finance 80 percent of the lower amount, or $144,000 rather than $160,000. That leaves a shortfall of $16,000 — which you would be on the hook for.

A low appraisal usually comes as a surprise. That's because comparable sales figure prominently in an appraisal. Since the seller determines a listing price by looking at comps and the buyer determines an offer price by looking at comps, it seems that the appraiser would be using the same comps and would get the same result.

Why might an appraiser's comps come in with a lower amount? There are a few common reasons that homes appraise too low. These include:

• ​Seller's market​. Bidding wars can force sale prices higher than the actual value.
• ​Buyer's market​. Sellers may be unaware of how much prices have gone down in a shifting market, and foreclosure sales and short sales can affect the comps.
• ​Incompetent appraisal​. This can happen with an inexperienced or poorly trained appraiser.
• ​Old or inappropriate comps​. An appraiser relies on comparables
  to determine value. If the appraiser pick comps that are too old or too dissimilar, the appraisal can come in low.

When the appraised value of the property comes in lower than the agreed-upon purchase price, the loan terms change. The dollar amount the mortgage will provide goes down with a lower appraised value.

Remember that the contingency for an appraisal doesn't automatically nullify the deal; it just gives the buyer the option to back out of it. If you are the homebuyer and you want to back out, you have the legal right to do so, and this should always be considered an option. However, if you want to fight for your dream home, you have a variety of options to pursue.

The first action you should take if faced with a low appraisal is to try and figure out what's going on. Review the appraisal and the comps and have your real estate agent do the same. If the comparables are inappropriate, old or erroneous, you can challenge the appraisal and ask the lender to get another.

Since the buyer pays for the appraisal, expect to spend money on a second one. If you are convinced that the appraisal was flat-out wrong or simply inexplicable, it may be worth it. Even if the lender doesn't agree, you can go ahead with a new appraisal, and assuming that it comes in higher, you can use that to argue your case to the lender.

Maybe you read the appraisal and find that it makes sense. Don't judge yourself harshly; you aren't the first person blinded by the dazzle of a dream home or caught in a bidding war for an appealing property. You still may be able to work out the purchase.

Working with a willing seller is a top option if the lower appraisal valuation was justified. Approach the seller, discuss the reasons for the lower value and see if the seller is prepared to lower the price. This can depend on whether the seller has other interest in the property. If so, the seller may be less willing to lower the price. In a buyer's market, however, you will have more leverage.

Alternatively, you can solve the issue by paying the difference out of pocket. If you have the cash, you can simply put it on top of the deal. If not, try to work out a deal with the lender that allows you to reduce your down payment and increase the mortgage amount. Then, you can use the extra down payment cash to cover the difference between the appraised value and the purchase price.

If the seller won't reduce the price and there's no extra cash, you can still open negotiations to make the sale work. Exactly what you might offer depends on the circumstances of the sale. What concessions would your seller find attractive enough to reduce the price?

For example, if the seller had agreed to do home repairs as part of the deal or clear bulky junk out of the garage, offer to take those responsibilities out of the deal. Does the seller want a rent-back agreement? See if that might be a bargaining chip.

Don't forget your ultimate leverage. When the appraisal comes in low, you have the legal right to walk away from the deal.