When an appraisal comes in low

Luckily this hasn't happened often to me...last week we closed a transaction where the appraised value came in lower than the agreed sales price on the purchase and sale agreement.   Ugh! 

The property is a nice home in south King County that was originally listed for $275,000. Shortly after going on the market, a bidding war commences and my client "wins" the home after it is bid up to $300,000 which includes building in $6,000 of closing costs to be paid from the seller.  My client is putting zero down into the transaction (100% loan to value).

The appraiser is faced with many challenges in this scenario.

• How can he justify the significantly higher sales price over the list price?
• Finding like properties, also referred to as "comps" or "comparables" (a small split entries with similar square footage of 700 on the main floor) that have recently sold and closed.
• Finding these comps within a radius close to the subject home.
• Stacking in a significant amount of closing costs into the sales price. 

From the appraiser's point of view:

"It's a touchy issue because a sales price over and above the listing price is difficult to deal with.   If you look at it objectively, why would anyone pay over the listed price in the absence of a bidding war, especially if the property has been on the market more than a couple of weeks.   If it was worth more than the listed price, one would think it would have sold right away.   In the present environment (sub-prime problems) the appraisal is getting scrutinized more than ever before.   This makes the adding on closing costs issue harder and harder to deal with."

The home in this scenario appraised for $285,000.  So what happens next?   When it comes to determining the value of a property, the lender is going to use the lesser of the sales price or appraised value.   If the home would have appraised for $320,000; the lender would use $300,000 for the value; with the home appraising for $285,000 this is now what the lender will base the loan on when factoring loan to values.

The buyer has a couple of options from the lender's standpoint.

1. The sales price can be reduced to the appraised value of $285,000.   Since this loan was 100% financing, the loan amount was also reduced to $285,000.   If the loan amount was not based on 100% of the value, the loan can be restructured.   For example, if the buyer was planning on putting 20% down on a $300,000 home, their loan amount would have been $240,000.   Now with a value of $285,000 their new loan to value is 84%.   The buyer either reduce their loan amount to $228,000 to keep the same program and pricing that an 80% ltv loan would have, or they can opt for a different program (such as LPMI, PMI or do a piggy back mortgage) with the 84% loan to value.  The loan would be repriced accordingly.
2. The buyer can bring in cash to make up the difference.    If the seller will not reduce the price to the appraised value, and the buyer still really wants that home, the buyer can bring in the difference between the appraised value and sales price, in this case $15,000.   The loan amount would remain $285,000.   The $15,000 (difference between the sales price and appraised value) would need to be sourced and seasoned.
3. The buyer (or seller) can decide to not close the transaction.   Depending on how the purchase and sale agreement is written and what contingencies have been removed, the buyer may or may not receive their earnest money deposit back in this scenario.   
4. The Seller can elect to obtain an appraisal.  The appraisal must be from an appraiser who is approved with the lender and be the correct type of appraisal based on the loan approval.

In this case, the seller agreed to lower the price to the appraised value (it was still more than what they had listed the home for even after factoring in the seller paid closing costs).   The buyer wound up with a lower sales price and lower mortgage payments. 

Just because a buyer is willing to pay a certain amount for a home, does not mean that the lender will finance it based on the purchase and sale agreement.   Not all appraisals come in "at value".   Often they may be a little above the sales price and once in every blue moon, they even come in lower.