In Greater Boston, buyers gearing up for the spring’s purchase market will need to plan how they’ll navigate the very competitive terrain.
If you’re buying with financing, your offer strategy will need to address appraisals. If your appraisal comes in below your offer price, you may need to make up the difference––in addition to the amount of your down payment.
If you’re selling, you’ll likely look at terms as well as price, including how much financing will each buyer’s offer require and how a buyer might handle a low appraisal.
What is an appraisal?
When a buyer applies for a mortgage, a lender needs to determine whether the buyer’s purchase price is warranted, and thus worth lending on. A lender will only provide a loan amount based on the appraised value or less. If a buyer offers $500,000, but the appraiser determines the appraised value to be $485,000, the lender will only provide a loan based on the amount of $485,000.
The lender hires an independent appraiser (at the buyer’s expense) to view the property and produce a report (an appraisal) explaining to both buyer and lender their estimate of the market value—based on the property’s location, condition, and amenities, and the appraiser’s educated judgement of comparable sales.
(What an appraiser deems to be comparable can be debatable, depending on how well they know the area and the availability of relevant, recent comparable sales.)
Comparing offers with financing and appraisals
Sellers will want to compare offers in terms of risk. If the property were to appraise at an amount lower than the offer price, how would the seller fare with each buyer? Essentially, which buyer represents the least risk?
The buyer who needs the least financing (and who may likely have enough extra funds to cover the shortage from their own pocket) is the least risky option for the seller to choose. Buyers are wise to illustrate to a seller up front the extent to which they’re capable of absorbing any potential appraisal issues.
Let’s say we have three buyers who submit an offer at the same price of $500,000:
- Buyer A requires 95% financing (with a 5% down payment)
- Buyer B requires 80% financing (with a 20% down payment)
- Buyer C requires 50% financing (with a 50% down payment)
But if there is an appraised price of $485,000, here’s how much each buyer would have to pay to cover the appraisal shortage:
| Down payment amount | Amount of financing buyer would want for $500k offer price | Amount bank would lend for $485k appraisal | Appraisal shortage | |
| Buyer A | $25,000 (5%) | $475,000 | $460,750 (95% of appraised $485K) | $14,250 |
| Buyer B | $100,000 (20%) | $400,000 | $388,000 (80% of appraised $485K) | $12,000 |
| Buyer C | $250,000 (50%) | $250,000 | $242,500 (50% of appraised $485K) | $7,500 |
Buyer A would have to come up with more out-of-pocket costs than Buyer B would, and well more than Buyer C.
In proportion to the funds each buyer is already committing for a down payment, the seller would presume that:
- Buyer C could fairly easily come up with an extra $7,500 out of pocket;
- Buyer B would have a bit more of a stretch to make for $12,000; and
- Buyer A might be entirely halted by $14,250.
Thus, the seller would regard the offer of Buyer C as least risky. Buyer B would be a solid second tier that the seller likely could work with to get close to the agreed upon price.
How to avoid appraisal issues
An array of offer strategies can head off potential appraisal issues. Here are a few that buyers consider:
- offer up front to cover any appraisal differential (this may be based on guesses that overall market values are heading upward for that location)
- offer up front to cover X amount of an appraisal differential up to a set max amount
- offer to waive the financing contingency altogether (some buyers determine that they can afford this risk, based on various factors, but it should be considered cautiously)
