Low Appraisals

Many buyers are purchasing homes well above list price.  So what happens if the appraisal comes in low?

To be clear, low appraisals have not been an issue.  The only low appraisals we've seen in years have been appraisals we knew would come in low (I'm looking at you, 400 sq ft waterfront cabin on five acres).

However, it's best to understand the implications of a low appraisal so you're prepared for every outcome.  When an appraisal comes in low, the buyer typically has the choice to:

a) re-negotiate the purchase price
b) decline to buy the house entirely
c) do nothing and buy the house anyway

What are the implications of buying the house anyway?  That depends on the buyer's down payment.

When we approve a loan, we agree to loan a buyer a percentage of the home's value.  And we define a home's value as the lesser of the purchase price or the appraised value.  This is best understood if we look at a few examples.

Example #1

Little Miss Muffett is buying a spider-free home for $450,000.  She's only putting 5% down, which means we're loaning her 95% of the value of the home (or "loan to value").  She was hoping to borrow $427,500.  But her appraisal came in at $425,000.  Now the maximum we'll loan her is $403,750 (95% of $425,000).  So instead of a down payment of $22,500, she'll need $46,250.  She'll have to cover the difference between the appraised value and the purchase price on her own.

Example #2

Jack and Jill are buying a home atop a high hill for $450,000.  They're putting 20% down, which means we're loaning them 80% loan to value.  They were hoping to borrow $360,000.  But their appraisal came in at $425,000.  Now the maximum we'll loan them (at 80% loan to value) is $340,000.  So instead of a down payment of $90,000, they'll need $110,000.  What if they don't have the extra cash?  We could still loan them $360,000.  But now we'd be loaning them 84.7% loan to value instead of 80%.  And they'd have to pay mortgage insurance.

Example #3

Humpty Dumpty is buying a home with no high ledges for $450,000.  He's putting 40% down, which means we're loaning him 60% loan to value.  Humpty was hoping to borrow $270,000.  But the appraisal came in at $425,000.  Now the maximum we'd loan Humpty at 60% loan to value is $255,000.  But who cares if Humpty has 60% loan to value or 63.5% loan to value?  There's no difference in interest rate, pricing, or anything else I can think of.  In this instance, because Humpty is making such a large down payment, he could continue to borrow $270,000 and invest the same amount of money at closing - albeit with a slightly smaller down payment.

This is handy info to keep in mind when considering an offer well above list price or comparing multiple offers with your sellers.  In the unlikely event of a low appraisal, the larger the down payment, the less likely the financing will be impacted.