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Could the fluctuating home market cause a large appraisal gap?

On Behalf of | Jul 9, 2024 | Real Estate Law

The real estate market fluctuates from day to day and year to year. On a long-term scale, prices tend to appreciate a bit over time. However, the market can fluctuate substantially based on a variety of factors. For example, an increase in demand for housing in certain markets driven by remote work led to an increase in home values in recent years.

Federal policy attempts to contain inflation help slow the real estate market in many locations. However, prices have risen noticeably in many areas and have declined in some others. Those changing prices can put buyers in a difficult position during residential real estate transactions. They may have to prepare for the possibility of having an appraisal gap if their offer is generous.

What causes an appraisal gap?

An appraisal gap is what occurs when the professional who evaluates the property determines that it is worth less than the amount the buyers offered to pay for the property. An appraiser looks at the condition of the property and the sale prices of comparable properties on the local market to set a fair market value for the home. If the appraiser determines that the amount offered is higher than the fair market value, the gap that results can complicate the real estate transaction. Lenders typically do not move forward with full financing for scenarios involving an appraisal gap.

How can buyers respond?

There are a few potential solutions available when an appraisal gap suddenly threatens a real estate closing. The buyers and the seller may be able to renegotiate the price to move forward as planned with the transaction. In some cases, the buyers may need to look for ways to cover the difference between what they offered and what the appraiser believes the property is worth. Occasionally, looking into a different financing option and securing a second appraisal could correct the situation. However, there’s never any guarantee that a second appraisal is certain to eliminate the appraisal gap.

The best protection comes from making an offer that reflects the fair market value for the property as the local market fluctuates. That can be a very challenging undertaking for the average buyer. Including the right protections in offer documents can also be important for those at risk of a potential appraisal gap. Buyers also want to include language in their offers and purchase agreements that can protect them from the loss of their earnest money if an appraisal comes in too low for them to close on the transaction.

Being prepared for various challenges caused by the current real estate market can minimize the financial risk involved in acquiring real property. Contractual protections and an understanding of the market are crucial for risk such minimization.