What Happens With a Low Mortgage Appraisal on a Home?

Reader question: "Some friends of ours recently bought a home in the same area where we are planning to buy. They had a problem with their financing because the appraisal report came in lower than the offer / purchase price. Is this a common scenario? What happens if the mortgage appraisal is low? Are the buyers stuck in the contract?"

Let me start with the short answer and expand from there.

You should consider writing an appraisal contingency into your purchase agreement. This gives you a way to back out of the deal if the appraisal comes in too low. If you do this, you won't be "stuck" in the deal, nor will you lose your deposit money.

You could also negotiate with the seller to reduce the purchase price. Some will negotiate, while others won't. It partly depends on how competitive your local real estate market is.

Low Appraisals a Common Occurrence

You also asked if this was a common scenario for home buyers. I would say it's a lot more common today than it was five or six years ago. The reason is that we've seen a decline in home prices across the country.

In a rising market, where home prices are steadily appreciating, it's much more rare for the mortgage appraisal to come in low. The only time it happens in a rising market is when the sellers have totally overpriced the home. But it's happening a lot today because some sellers don't realize how much value they've lost.

Here's a realistic scenario to illustrate my point:

The Andersons bought their home in 2003, when we were still experiencing a housing bubble in America. Home prices were climbing up a steady slope, and they had been for some time. The Andersons paid $500,000 for the house.

Eight years later, they need to sell the home because of a job transfer. They know home prices have dropped because of the housing crisis. But they figure if they list it close to the price they paid eight years ago, it will all work out. Their equity rose after they paid $500,000 for the house, and then it dropped again when the housing bubble popped. So they believe they're right back where they started from, in terms of property value.

So the Andersons list their house for $499,000. You stumble across their home in the course of your house-hunting process, and you instantly fall in love with it. You think it might be a little overpriced. But it has everything you could ever want from a house. So you make an offer of $485,000. The Andersons accept your offer, and then you present your purchase agreement to your mortgage lender for approval.

What happens next is a very critical part of the process, and it relates to the question you asked.

Enter the Home Appraiser

The home appraiser looks at recent sales data for the area, in order to determine the value of the Anderson's home. He or she will also visit the property to see if they have any upgrades or unique features that would increase the value. The appraiser represents the mortgage lenders interests -- not yours or the Anderson's. The lender is paying the home appraiser to perform this function in order to protect their investment.

After completing his research, the appraiser tells the lender the home is not worth $485,000. The appraised value comes in closer to $385,000. This is the exact scenario you asked about. The mortgage appraisal is too low to support the agreed-upon purchase price.

The Andersons thought the value might have dropped back down to the level when they first bought it. But it actually fell below their original purchase price. It's a common scenario. 

In this scenario, the lender would not loan you any more than the appraisal amount. In fact, they would offer you less than that amount because of your down-payment requirements. For example, if they imposed a maximum loan-to-value ratio of 90%, you would have to come up with the remaining 10% in the form of a down payment. So the lender would only be willing to give you 90% of $385,000 (the appraised value of the home).

The Importance of Using Comparable Sales

This is why you must look at comparable sales data before making an offer on a house. Real estate agents refer to these as "comps." These are similar homes that have sold recently in the area where you are planning to buy. I'm not talking about listing prices here. I'm talking about the actual sales price -- the amount the homes sold for in the current market.

This data will help you determine whether the seller's asking price is realistic or inflated. Your real estate agent should do much of this research for you. It's what you're paying them for. But you can also research it yourself by looking at recent sales on Zillow.com, or any other website that offers sales data.

If you use comparable sales to support your offer, you'll be less likely to have a situation where the mortgage appraisal comes in low. You'll also be able to spot (and avoid) homes that are extremely overpriced.

The Home Appraisal Contingency

Even if you do the necessary research and make a smart offer, there's a chance the mortgage appraisal will come in lower than the purchase price. So what can you do in this situation?

The first thing you need to do is prepare for this scenario in advance. When you make an offer to buy house, the offer should be contingent upon certain things. A "contingency" simply means that certain conditions must be met in order for the deal to go through. One of those conditions should be the mortgage appraisal itself.

An appraisal contingency gives you the right to back out of the deal, if the appraisal comes in low (and the seller refused to reduce the price). You would simply add a standard clause to your contract that says, "If the house is appraised below the agreed-upon purchase price, the buyer can exit the contract and reclaim any earnest money deposit that was made." It would obviously be written in more legal terms. But that's the gist of it.

So if the mortgage appraisal is too low to support the sale price, you have a way to back out of the deal. Of course, it might not come to that. The seller might be willing to lower the price to match the appraisal amount. So let's talk about that scenario next.

Reducing the Sale Price

Some homeowners price their homes based on the amount they need to get out of the deal. This means they set their asking price at a level that allows them to pay off their mortgage loan. This is a flawed pricing strategy. The homeowner's current mortgage balance has absolutely nothing to do with the current value of the home. They are two separate things entirely. A smart homeowner will price the home based on recent sales data in the neighborhood.

There's a broad spectrum between reality and fantasy, and you may encounter a home seller that falls anywhere on the spectrum. If the sellers are realistic, they may be willing to lower the purchase price to match the mortgage appraisal amount. This is the best-case scenario for you as a home buyer, because it means the mortgage loan will probably go through.

When to Walk Away

But what if the seller doesn't agree to lower the price? In that scenario, you have two choices. And one of them might not be an option at all, depending on your lender. You can simply take your deposit money and walk away from the deal (if you included a contingency that allows it). Or you can try to pay the difference out of pocket.

It's generally not a good idea to pay more for a home than it's worth. If the appraisal is much lower than the purchase price, you could wind up in a negative-equity situation right from the start. The threat of depreciation compounds the problem. But if the appraisal is only slightly lower than the purchase price, you might choose to pay the difference by increasing the size of your down payment. It all comes down to what your lender will allow, and what you feel is the true value of the home.

It's also worth noting that some mortgage lenders will not allow any type of negative-equity situation. They view this as a risky investment. So if the mortgage appraisal came in low, and you agreed to pay the difference out of pocket, the lender could still withhold financing.

Like I said, the best-case scenario is for the seller to reduce the purchase price to match the appraisal. Some are willing to do this, while others are not. It's a case-by-case situation.

Is the Appraisal Accurate?

Lastly, I would encourage you to disputes mortgage appraisal that you think might be inaccurate. Home appraisers are not perfect. Some of them do a good job assessing the value of certain property, while others seem to pull numbers out of the clear blue sky.

Consider the following comment from Julie Vanderblue, a real estate agent from Fairfield, Connecticut: "I have seen appraisers come from different counties who really do not or understand the values in our market. If they are not even familiar with the area, it makes it near impossible to come up with the accurate value."

Let's revisit some of the key points made in this article.

  • Because of the declining home values we have seen over the last few years, it's common for a mortgage appraisal to come in lower than the asking price.
  • You should include a contingency in your purchase offer to account for this scenario.
  • The contingency will give you a legal way to back out of the deal if the seller refuses to lower the price.
  • A smart seller will reduce his asking price if he/she feels the appraisal is accurate. But some homeowners are simply delusional. They are unwilling to accept how much value they have lost over the last two years.
  • If you encounter a stubborn seller with an inflated asking price, don't hesitate to walk away from the deal.

Note: We have a follow-up article that explains what happens once the appraisal has been completed, if you'd like to continue your research.

This article explains what can happen if the mortgage appraisal is low, and what your options are as a home buyer. If you would like to learn more about anything discussed in this lesson, you can use the search tool at the top of this page. This website offers hundreds of lessons on home-buying process, mortgage loans, and other topics relevant to the modern-day home buyer. The search tool is the fastest way to find what you need. Good luck!