What is an Appraisal Gap Clause?

In the past few years, multiple offer situations have created intense competition, resulting in desperate buyers eager to bring just about any negotiating tactic to the table to set them apart to sellers.
 
One such tactic is called an Appraisal Gap Clause.

When purchasing a home, one of the standard contingencies is a home appraisal (unless of course, the buyer is paying cash).
 
A home appraiser working for the buyer's lending bank determines the value of the home based on recent sales in the area and the condition and location of the home (much like a realtor when determining a market price). The appraiser measures the home, takes pictures, and then prepares a report to send to the bank. The bank wants to ensure that your home is worth the contract purchase price you have negotiated as part of your purchase agreement. Or mostly, that your home loan is a worthy investment for the bank.

With multiple offer situations driving up prices in the tens of thousands, sometimes the bank feels the home is not worth the contract purchase price negotiated and this is where an appraisal gap clause could come into play.

If the appraised value is at the contract purchase price (or above), as it often is, then the buyer can remove their appraisal contingency and move forward with the purchase of the home. 

If the appraised value comes in below the contract purchase price, the buyer may have agreed to implement an appraisal gap clause.  An appraisal gap clause is a purchase agreement term stating that the buyer agrees to bring in additional funds up to a certain amount if the appraisal value is below the contract price.

For example, if a buyer agrees to cover an appraisal gap up to $50,000 and offers $525,000 on a home that only appraises at $475,000, then no additional negotiations on the price would be required even though the appraisal came in low and the $50,000 difference would be paid for in cash by the buyer.

However, if the contract price is $525,000 and the appraisal comes in at $475,000 but the buyer only agreed to cover a gap of only up to $20,000, there are a few possible paths:

• The buyer could agree to cover the additional $30,000 appraisal gap with cash.

• The buyer and the seller could negotiate a new purchase price.

• The buyer and seller are unable to come to an agreement the purchase agreement is canceled. 

Appraisal gaps are just one reason why this can be a complicated market to navigate, with home prices escalating so quickly, sometimes the comparable home information is quickly outdated. It is important as both a buyer and seller to navigate all of your options and feel comfortable with what you ultimately decide.