What If the Appraisal Comes in too Low?
As real estate brokers in New York City, many buyers ask us what options exist if the appraised value comes below the contract’s purchase price. We explain how the appraisal rebuttal process works and how to prevent a low appraisal in the first place. Here are the most frequent questions buyers ask us. For this reason, we will draft this article like a Q&A.
- What happens when the appraisal is below the purchase price?
- What to do when the appraisal comes too low?
- How to contest a low appraisal?
- Can a buyer exit a deal if the appraisal is too low?
- Can a seller exit a deal if the appraisal is low?
- Is paying over appraisal a good idea in NYC?
- How can I prevent a low appraisal?
- What is an appraisal rebuttal and how long it takes?
- How often do appraisals get changed?
1. What happens when the appraisal is below the purchase price?
It means that the buyer’s lender will only issue a loan calculated on the appraised value instead of the purchase price. As a consequence, the buyer will experience a financing shortfall we call the “appraisal gap.” For example, let’s assume the contract price is $800k and the appraisal comes at $750k. The bank will no longer extend a mortgage of $640k ($800k x 80%) but will now lend $600k ($750k x 80%). This impact creates a shortfall of $40k, which is a financing gap for the buyer. IF the appraisal comes low, the bank will typically keep the loan-to-value unchanged. As a consequence, the buyer will have to put down an extra $40k.
A contract with an appraisal contingency or a minimum loan amount contingency will let the buyer get out of the contract to get his deposit back due to this low appraisal. Otherwise, the buyer needs to come up with an extra $40k down payment on closing day.
However, suppose there is a live deal. In that case, we recommend buyers and sellers try to keep the deal alive by utilizing various low appraisal response strategies, which we explain below.
2. What to do when the appraisal comes too low?
There are several approaches to react to a low appraisal in New York City.
- Buyer can increase the down payment. The most straightforward response to a low appraisal in NYC is for the buyer to increase the down payment to cover the financing gap. When the appraised value is very close to the contract price (think several thousand dollars), most buyers are comfortable slightly increasing the down payment. If the appraisal comes in way below the purchase price, buyers tend to be more reluctant. This consideration is even more true in New York City vs. any other city in America. For instance, if you are buying a co-op, increasing the down payment mathematically reduces your post-closing liquidity and puts the whole deal at risk of not meeting the co-op’s requirements.
- Get the seller to lower the contract price. The seller can agree to decrease the contract price to equal the appraisal value. Most sellers won’t agree to it, especially if they are not legally obligated to. Some sellers also feel that the appraisal is inaccurate. Think of an appraiser using comps of a forced seller during the COVID pandemic.
- The buyer and seller can try to renegotiate the purchase price. As brokers, we usually suggest buyer and seller meet in the middle. We encourage them to sign a new contract price as the midpoint between the appraisal and the purchase price.
- Buyer can apply for a loan with a new bank. When the buyer and seller disagree on a new price, the buyer may apply for a new bank loan. The new bank will order a new appraisal. This decision is like rolling the dices a second time! This decision will come at a cost because the buyer will have to pay for the bank origination fee and appraisal fee but could have higher leverage. We currently do not recommend this approach for two reasons:
- In the context of rising interest rates, the new mortgage lock will presumably carry a higher interest
- This can delay the co-op board approval process by several weeks, and in some cases, the buyer could be in default based on the deadline obligations in the contract.
- Buyer can challenge the bank appraisal. The buyer can challenge the bank and ask to reconsider the appraisal judging it too low. This approach only works if there are errors in the appraisal report. The buyer can also claim the appraiser did not include the best comps.
3. How to contest a low appraisal in NYC?
The buyer can contest a low appraisal by submitting an appraisal reconsideration with the bank. This process typically takes around two weeks. This approach will only work if the appraisal report contains factual errors. The buyer can also try to demonstrate the appraiser forgot key comparable properties. Mistakes can be incorrect square footage or inaccurate room count. It takes a couple of weeks to hear back once the buyer has submitted the reconsideration to the mortgage banker.
When the process is complete, the appraisal firm provides the buyer with an “Appraisal Reconsideration Response’.” This document addresses each additional comparable or factual error presented. The “Appraisal Reconsideration Response” may lead to 2 outcomes.
- if the appraised value is higher, the bank can lend against the new value.
- If there is no change, the bank will keep the mortgage size unchanged.
4. Can a buyer exit a deal if the appraisal is too low?
A buyer can only if there is an appraisal contingency in the contract. If the contract is non-contingent, the buyer has the legal obligation to close the deal by putting more money down.
5. Can a seller exit a deal if the appraisal is low?
Yes. The seller can push the buyer to cancel the deal by not agreeing to reduce the purchase price. Suppose the seller is unwilling to lower the contract price down to the appraised value. Therefore, the buyer can use his mortgage contingency to cancel the transaction.
6. Is paying over appraisal a good idea in NYC?
Yes and No. If you believe the appraisal is inaccurate, don’t put too much weight on it. However, if you feel that you’ve overpaid, you may want to include an appraisal contingency. This strategy might give you the option to renegotiate the price down the road.
In the grand scheme of things, the buyer will hold the property for a long time. As a result, a slightly higher purchase price is not pivotal in light of price appreciation.
7. How can I prevent a low appraisal?
There is no way to prevent an appraiser from issuing a low appraisal value. However, there are ways to mitigate a low appraisal risk by applying with multiple banks simultaneously. The buyer has to pay for multiple appraisals. However, this approach gives two chances on the appraisal. It will save time vs. waiting for one appraisal and then starting an entirely new process after a first appraisal comes too low.
To mitigate the risk of a low appraisal, the brokers can provide the appraiser with relevant comps. There’s no guarantee the appraiser will use the comps provided. However, those comps may help get a higher appraisal.
8. What is an appraisal rebuttal and how long it takes?
It is the process of challenging the appraisal. They take about two weeks after the buyer submitted the contested items in the appraisal.
It is not likely for an appraisal rebuttal to result in an increased appraisal value. Appraisers will review them and consider if there are factual (not subjective) errors. They may change the appraisal value if they have omitted obvious comps from the original report.
9. How often do appraisals get changed?
Very rarely. Since we started NestApple in 2017, we have not seen or even heard a single instance.
A buyer can submit an appraisal appeal to the bank if the appraisal has obvious factual errors. Therefore, it’s always possible that the appraised value will be increased. Even if the appraisal appeal increases the appraised value, it still may not match the contract price. At least there is no guarantee. Often, it’s faster to apply for a new bank loan. The new lender will order a new appraisal.
Your broker needs to determine if a property is at risk of a low appraisal. If you are buying in a hot market (such as the Catskills or the Hamptons during COVID times), we recommend buyers to apply for a mortgage with multiple banks early on. Doing this will give you the protection of two interest rate locks and the opportunity to hit the contract price with two separate appraisals.
By Georges Benoliel. The author is the co-founder of disruptive real estate start-up NestApple. Georges has been working in Wall Street for the last 17 years trading derivatives and mortgages with hedge funds. He has been an active real estate investor for over a decade. Mr. Benoliel graduated from HEC Business School in Paris and holds a Master’s in Finance from ESADE Barcelona.